Question 1

How does compound interest actually work?

Accepted Answer

Compound interest is interest earned on previously-earned interest. In month one you earn interest on your principal; in month two you earn interest on the principal plus the first month's interest; and so on. Over decades, the interest-on-interest effect dominates — most of your final balance comes from compounding, not from your contributions.

Question 2

What's a realistic compound return rate?

Accepted Answer

Depends on the asset. UK cash savings currently average around 3–5%. A diversified global equity portfolio has historically returned around 7% nominal per year over long periods. Government bonds sit lower, around 3–5%. The longer the horizon, the more important it is to match the rate to the asset — small differences compound into very different end values.

Question 3

Should I use nominal or real returns?

Accepted Answer

Both views matter. Nominal returns are what you actually see on your statement. Real returns subtract inflation — they tell you what you'll be able to buy. At 7% nominal and 2.5% inflation, your real return is about 4.4%, which is the figure that matters for retirement planning. PigE shows both side-by-side.

Question 4

How does monthly contribution compare to lump sum?

Accepted Answer

A lump sum invested upfront compounds for the entire horizon. Monthly contributions get fewer compounding years (the contribution made in year 25 only compounds for 5 years if your horizon is 30). For a 30-year horizon at 7%, a £100,000 lump sum grows to about £761,000 — the same total contributed monthly over 30 years (£278/month) grows to about £343,000. Both useful, very different.

Question 5

How often should interest compound?

Accepted Answer

For long-term investments the difference between monthly and annual compounding is small — about 0.3% per year at a 7% rate. UK savings accounts typically advertise an AER which already factors in compounding frequency. This calculator uses monthly compounding because that's how most regular-contribution investing actually behaves.

PigE — UK pension forecast & retirement calculator

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