Article Compound interest explained: Putting your money to work

What is compound interest?

Compound interest is a type of interest earned on the original money you’ve saved and on any previously paid interest. Essentially, it’s a way you can earn interest on the interest itself. The power of compound interest could be underestimated, but there are potential benefits to earning a return on your initial capital and reinvesting your gains.

How does compound interest work?

When you earn interest on your savings, you can either spend that interest or let it stay in your account. If it stays in your account, then that money will start to earn interest as well. The additional interest may seem small at first, but over time, the compounding effect could increase as your balance grows.

This popular thought experiment effectively illustrates the concept of compound interest. It may seem like a 1 million payment is the smart choice, but starting with a single cent and doubling your money every day (1 cent, 2 cents, 4 cents, 8 cents, and so on) adds up to 10,737,418.24 million at the end of 1 month!

But the odds of finding magical coins (or investment opportunities) offering daily returns of 100% are extremely low, so let’s look at a more realistic calculation example below.

Let’s assume you’ve got 5,000 CHF available and can invest this at a rate of 8% each year. You can choose to either withdraw your gains or reinvest them every year. The first option should allow your money to grow to 17,000 CHF over 30 years. But if you choose to reinvest your gains, you could generate returns on both your initial capital and your accumulated earnings.

As Figure 2 of our thought experiment shows, the second option will see your investment grow to 5,400 CHF over the first year. And the year after, you’ll earn interest not only on your initial capital of 5,000 CHF but also on the 400 CHF gain you’ve made in the first year. As you continue to leave your money during this example invested and earn returns on both your initial capital and accumulated gains, your investment will continue to grow at an accelerating rate. After 30 years, your investment will have increased tenfold to over 50,000 CHF.

Saving regularly can help you reach your financial goals.

For example, a 30-year-old teacher from Hamburg – let’s call him Michael Schmidt – has recently inherited a sum of 25,000 CHF from his grandmother. He decides to invest this in an ETF mimicking the growth of the MSCI World Index.

Each month, he allocates 150 CHF from his salary to his investment account, and he doesn’t withdraw a cent until he reaches the age of 65.

Can you guess how much his portfolio would have grown by then?

For the past 10 years (1 August 2015 to 31 July 2025), the index provided an annualised return of 12.05%*. So in this hypothetical example, we will use that to calculate potential growth.

In the 35 years between his initial investment and the day he turns 65, Michael’s portfolio could grow to CHF 2.648.785. Here's how:

• He would have made an initial investment of 25,000 CHF.
• His monthly payments amounted to 63,000 CHF.
• The growth of the investment alone could amount to CHF 2.560.785.

The above calculation was done through our savings plan calculator. Why not try it out to see how saving regularly can help you meet your long-term financial goals?

*Performance represents the annualised return over the last 10 years (01.08.2015 - 31.07.2025). Source: Bloomberg, as at 31.07.2025. Past performance is no guarantee of current or future results and should not be relied upon as the sole basis for selecting a product or investment strategy. Index return information is provided for illustrative purposes only. Direct investment in the index is not available.

FAQs

What is compound interest?

Compound interest is earned on previously earned interest.

What is the difference between compound interest and simple interest?

Simple interest is calculated only on the initial principal amount, resulting in steady growth. In contrast, compound interest is calculated on both the original amount and any interest earned in previous periods, leading to quicker growth over time.