When you put your money into a savings account, it isn't just sitting there. It grows, thanks to interest.
But it’s not just the interest rate that you need to look out for. You also need to pay attention to how often that interest is compounded. (Spoiler: the more frequently it compounds, the better.)
So, first things first: Interest is the money you can earn on your savings account's balance. It’s the cash you earn for letting a financial institution use your money until you need it and it is expressed as a percentage.
Interest is usually added to your account, or compounded, daily, monthly, quarterly or annually, depending on the account. The rate at which interest compounds affects how fast your money grows. When interest compounds daily, it’s added to your account more often, so your savings grow more, too.
Compounding interest is essentially earning interest on your interest. The interest you earn is added to your balance, so when the interest compounds again, you earn interest on a slightly larger balance.
All things being equal, a savings account that compounds interest could earn you more interest than a savings account with simple interest. Learn more about compounding interest here.
How much interest you earn after one year assuming no funds are withdrawn, including all compounding interest, is the APY, or annual percentage yield. When shopping around for a savings account, APY is a good number to use to compare accounts. It gives you a holistic view of how much you could earn on your balance over the course of a year. If you see only the interest rate, you may want to look a little closer to find the APY.
Take a look at how much $10,000 can grow depending on how often the interest compounds.
A bunch of factors determine how much interest you earn on your compound interest savings account, including:
Also remember, the interest rate on savings accounts could change from time to time and that impacts how much you’re earning. Though banks set their own rates, rates also tend to change when the Federal Reserve raises or lowers the federal funds rate.
There are online compounding interest calculators to help you figure it all out. That’s a simple way, but you can also calculate interest in a savings account yourself by using a spreadsheet like Microsoft Excel or Google Sheets.
In Excel, you’d enter the following formula: =P*(1+r)^n.
P is the balance in your account, r is the interest rate for one compounding period, and n is the number of compounding periods over which you’re earning interest.