How To Get The Best Returns On Your ISA
10th December 2018
When looking for a place to invest your savings, you are likely to compare the interest rates offered by the different banks and investment platforms. But it’s not just the interest rate you have to pay attention to... have you considered the effect of compound interest? When the interest is calculated and paid can have a significant impact on your earnings in the long-term.
This is owed to the compound interest you might not earn. Compound interest is the money you earn on the interest you have already been paid. For example, when you invest £20,000 with Barclay’s Cash ISA, you will earn 1.05% interest after one year. Meaning if you made that investment last December, you would have £20,210 in your account today. Next year you will not just be paid 1.05% of the original £20,000, but on the £210 you earnt last year.
What happens if you are paid interest monthly, as opposed to annually? You are paid interest on what you have earnt every month before. This means you would now have £20,211.01 today, instead of £20,210.00. In five years time, you would have earnt an extra £5.29, just because the bank paid you at a different frequency.
Admittedly, £5.29 barely gets you a drink these days, but this effect becomes important when your investments have a higher interest rate. For example, Crowd2Fund’s investor community make around 8.7% APR on average with their Innovative Finance ISA (IF-ISA). Repeating the example but investing £20,000 in their IF-ISA, you would earn £1,740 interest in the first year and £1,891.38 the following year with annual compound interest. However, as the interest is paid monthly, you could earn another £83.71 in the first year, if you reinvest those earnings straightaway.
The powerful force of compound interest comes into its own for those looking to make long-term investments for their future. If you’re saving for 20 years down the line by investing £20,000 in an IF-ISA, where you are not taxed on the earnings, you could be looking at a balance of £113,233.84, instead of £106,076.91. That is £7,156.93 more paid to you, purely for reinvesting monthly, instead of annually.
How to earn monthly compound interest
Practically speaking, if you prefer to know exactly where your money is invested then you will need to actively reinvest your interest earnings each month as repayments are issued. To maintain a diverse portfolio, using the Exchange can offer more choice for your reinvestments. If you are unable to pay such close attention you may wish to use an automated feature such as Smart-Invest.
To learn more about increasing your compound interest and getting the best rates of return, check out our Investor Top Tips page.
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