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How does compound interest affect my savings account?

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Increase your earnings exponentially with a compounding account.

To see the strongest returns on your savings, you need to compare more than just interest rates. How and when an account pays you interest can greatly affect your savings potential. Compound interest is a magical tool: The more frequently your balance earns interest, the more quickly your savings grows.

How do banks calculate compound interest?

With most savings accounts, interest is calculated every day on your daily closing balance.

Compound interest formula

Here’s the equation that most banks use for savings accounts:

(Daily closing balance) x (interest rate percentage)
365

Interest begins to accumulate on the day of your first deposit. It’s then credited into your account on the last day of each month. If you close your account, your accrued interest is deposited on the day it’s closed.

Any interest awarded to your savings account is typically available for use on the same day it’s credited.

Use our compound interest calculator

How can I figure out compound interest?

Compound interest is a complicated calculation that’s often easier left to online calculators designed for that purpose. Still, you can refer to the same formula banks use to calculate your compound interest:

Daily closing balance x interest rate percentage / 365

Say you invest $1,000 with an interest rate of 10% compounded annually for five years. Using the compound interest formula, you’ll find that your initial investment of $1,000 earns $100 after the first year, giving you a total of $1,100.

The total amount yielded for the first year will then earn $110 — 10% of $1,100 — as interest for the next year, bringing your balance to $1,210. This amount then becomes the base for compounding for the third year, and so on. After five years, your initial balance would total $1,610 due to compounding interest alone.

How does compound interest work in technical terms?

Think of compounding as a way of earning interest on your interest. A savings account with ongoing compound interest applies interest to the interest that you’re already paid.

Compound interest differs from simple interest, which is typically associated with loans. For loans, simple interest is calculated on the principal — or the original loan amount — only.

Again, it’s complicated. But we can get an idea of the benefits of compound interest on your savings by analyzing the mathematical formula associated with it:

Screenshot 2015-10-14 10.57.13

Here’s what those letters and annotations represent:

  • A — the future value of your total investment, including earned interest
  • P — your initial deposit amount or principal investment
  • r — the interest rate annually as a decimal
  • n — how often interest is compounded each year
  • t — the number of years the money is invested for

For most savings account, your interest is compounded monthly — or 12 times in a year. For long-term savings products, like certificates of deposit, the formula or compounding period may differ.

Case Study: How compound interest helps your savings grow

To better understand the benefits of compound interest, take a look at how one saver’s account grows depending on any number of factors found with your typical savings account.

Here, Miles deposits $5,000 into a standard savings account that pays interest at a rate of 3.5%.

Interest is calculated daily and deposited into the account at the end of each quarter:

Principal (P) Rate (r) Compound (n) Time (t) Interest earned after 1 year
$5,000 3.5% 4 1 $177.31

At that same rate for the next five years, here’s how much he’ll earn:

Principal (P) Rate (r) Compound (n) Time (t) Interest earned after 5 years
$5,000 3.5% 4 5 $951.70

If interest is paid annually, here’s where Miles’s interest earnings would stand after five years:

Principal (P) Rate (r) Compound (n) Time (t) Interest earned after 5 years
$5,000 3.5% 1 5 $938.43

If interest is compounded daily, here’s interest earnings after five years:

Principal (P) Rate (r) Compound (n) Time (t) Interest earned after 5 years
$5,000 3.5% 365 5 $956.18

Note that for accurate calculations, you can’t account for any withdrawals or fees deducted from the balance over the period you’re calculating. Adding to your balance also changes your results. We did say it’s complicated.

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Compare savings accounts that fuel interest compounding

Name Product Fee Minimum deposit to open Minimum balance to earn interest APY
$0
$0
$1
1.9%
Enjoy no monthly fees and a competitive APY with this online-only savings account.
CIT Bank Savings Builder High Yield Savings Account
CIT Bank Savings Builder High Yield Savings Account
$0
$100
$25,000
or set up a direct deposit of $100+ each month
2.15%
A super-high interest rate if you're in the habit of saving at least $100 per month or have $25K in the bank.
$0
$0
$0
1.9%
Earn one of the highest interest rates without the fees.
$0
$0
$0
1.9%
The most common services and transactions are free with Ally Bank.
$15 per month
(can be waived)
$25
$0
1.8%
Earn one of the highest interest rates if you have at least $10,000 in savings, and access your money by ATM, check or bill pay.
CIBC Agility Savings
CIBC Agility Savings
$0
$1,000
$0.01
2.16%
With no maintenance fees, it's easy to grow your savings. Put your money to work with an online account from CIBC Bank USA.

Compare up to 4 providers

What is interest?

In the context of lending, interest is the cost of borrowing money. When you take out a loan, you typically pay interest as a percentage of the principal amount at an agreed rate.

When it comes to savings accounts or investments, interest is the money you earn for allowing the bank, credit union or other financial institution access to your money. When you deposit your money into an interest-bearing account, you’re effectively lending money to the bank. Pooling together its members money is how banks and other lenders provide loans to borrowers, among other banking activities.

Many factors play into the amount of interest you ultimately receive, including:

  • The interest rate
  • How it’s calculated — for example, daily or monthly
  • How often it’s compounded and paid

The interest rate is often expressed as an annual percentage. The higher the interest rate you’re offered, the stronger your return.

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How can I find my monthly interest rate?

Your provider should prominently advertise the monthly variable interest rate under the product description for the particular account you’re looking at. It’s how they entice you to do business with them, and not a competitor.

If you’re not sure where to start, read our comprehensive guide to interest rates to see popular high-interest savings accounts. Note that interest rate are often variable, meaning they can change according to the federal interest rate.

How can compound interest work for me?

Compound interest is among the best ways to make your money work harder for you, helping you to reach your savings goals more quickly. Compounding can increase a small amount of money today into a large balance over 10, 20 or more years.

And you don’t need to be an investor to take advantage of it — anyone who can put away money can benefit from compound interest.

To get the most out of compound interest, deposit as much as you can into your account and limit any withdrawals from it, whether for bills or fun money. The more that’s in your account at the end of the month, the more interest you’ll earn.

Even if you can’t deposit extra money into your account, your balance continues to grow as your interest compounds each month.

What are the pros and cons of compound interest?

Compound interest is an incredible benefit. But it’s only one element to consider when shopping for a savings account.

Pros

  • Accessibility. Many savings accounts with compound interest allow you to withdraw or deposit whenever you need to. Meaning you can save and still easily access your money in an emergency.
  • Lower balance requirements. You can often stay in your bank’s good graces with a low balance.
  • Introductory rates. To compete for your business, many banks and credit unions offer higher introductory interest rates on savings accounts for a set time.
  • Increased earnings. With compound interest, your earnings increase exponentially — as long as you don’t withdraw funds.

Cons

  • Lower rates. Annual interest rates may not be as strong as money market accounts and CDs, which typically offer higher rates because interest isn’t compounded monthly.
  • Availability of funds. For some people, open access to savings is a drawback. You can easily dip into it for daily needs, ending up losing a portion of your interest earnings.
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How do I make the most of my compound interest?

To get the most out of an account with compound interest, save as early as possible and avoid unnecessary withdrawals.

  • Stay on top of your monthly minimum. Some accounts require a minimum monthly balance before requiring a fee. Keep more money in your own pocket by meeting that minimum.
  • Deposit what you can. Because compound interest helps your money make money, you can increase your earnings with routine deposits to your savings balance.
  • Avoid fees. Many banks waive fees for linking your savings and checking, directly depositing your paycheck or signing up for autopay. Ask about ways for you to get a leg up on your savings.

Frequently asked questions

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Shirley Liu

Shirley Liu is a program manager at finder, formerly the publisher for Banking and Investments. She is passionate about helping people make an informed decision, save money and find the best deal for their needs.

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