Typically, a deposit account earns either simple or compound interest. A simple-interest account pays interest on the principal amount. A compound-interest savings account earns interest on the principal balance and interest.
How To Calculate Compound Interest
If you want to figure out how much you can expect to earn in compound interest, an online calculator works. However, you can also calculate this amount on your own using this formula: A=P(1+r/n)nt A = Amount of interest earned P = Principal balance r = Interest rate n = Number of times interest is applied per time period t = Number of time periods elapsed (in months or years)
Example of a Compound Interest Savings Account
How frequently your interest compounds impacts how much interest you earn. That’s why it’s important to know if your interest compounds daily, monthly, quarterly, or annually. Let’s say you deposit $1,000 into a savings account that earns a 1% annual percentage yield (APY) and compounds every quarter. In the first quarter, you’ll earn $2.50 in interest on your principal balance. The next quarter, you’ll earn interest on $1002.50 instead of $1,000.
Types of Compound-Interest Savings Accounts
High-Yield Savings Account
High-yield savings accounts pay interest that’s higher than traditional savings accounts. In fact, some high-yield savings accounts could earn as much as 10 times the national average.
Money Market Account
A money market account is an account offered by banks and credit unions. It combines elements of a checking account and savings account. For example, the account earns interest and you can write checks from it. In some cases, you might not be allowed to make more than six monthly withdrawals, and there may be minimum balance requirements.
Certificate of Deposit (CD)
A certificate of deposit (CD) is a savings account where you deposit your money for a fixed period of time. CDs are available in a variety of term lengths, from just a few months to five years or more. In exchange for leaving the CD for the entire term, the bank pays you interest on the money you deposited. Withdrawing money from your CD before its maturity date may result in penalties.
Compound Interest vs. Simple Interest
The formula for calculating simple interest is: I = Prt I = Interest accumulated P = Initial principal balance r = Interest rate t = Time periods elapsed (in years)
