You might miss a great opportunity if your idea of investing in your future is tucking away money into a savings account. With a compound interest account, the interest earned makes money. — with no effort. Tired of watching your savings creep up over time? Learn how to grow your savings with a compound interest savings account.
What is a compound interest savings account?
A compound interest savings account pays interest on your total balance. Your earnings are calculated based on deposits plus interest accrued. The interest you earn makes money. Compounding interest starts slow, but soon the growth in your account speeds up over time.
How does a compound interest account work?
A compound interest account computes interest on your balance. The monthly interest you accrue adds to your account. In the following month, earnings are calculated based on the money you deposited and any interest you earned. Because interest is calculated monthly on a higher balance, your savings grow faster.
Compound interest vs. simple interest accounts
How your account calculates interest affects how much you earn. A simple interest account computes interest based solely on what you have deposited. If you open a savings account with a $1,000 deposit and a 6% interest rate, you will earn $60 interest for the year ($5 per month). After five years, you make $300 interest on your $1,000 deposit.
A compound interest account calculates interest on your entire balance. Using the same example above, you earn $5 your first month, giving you a balance of $1,005 in your account. In the second month, you will earn $5.02 as compound interest is calculated based on $1,005. At the end of the first year, you earn approximately $61.68 in interest. After five years, you could make $348.85 interest on your $1,000 deposit.
Formula to Calculate Compound Interest on a Savings Account
Wondering how to calculate compound interest on a savings account? Take a look at this formula.
A = P(1 + r/n)^(nt)
A = the future value of the investment/loan
P = the principal amount (initial deposit)
r = the annual interest rate (expressed as a decimal)
n = the number of times that interest is compounded per year
t = the number of years
4 popular compound interest accounts
Compound interest accounts have distinct features and benefits. Consider your financial goals when choosing a compound interest account.
1. High-yield savings accounts
High-yield savings accounts pay higher interest rates than traditional ones. The higher rate helps your savings grow faster when interest compounds. While many high-yield accounts do not require a minimum balance to open, you may need to maintain a certain balance to keep a higher interest rate. With a high-yield savings account, you can access your money anytime.
MoneyLion offers a convenient marketplace to compare high-yield savings accounts from our trusted partners that could help grow your money.
2. Certificate of deposit accounts
With a certificate of deposit (CD) account, you agree to let the bank use your money for a fixed period. Banks pay you a higher interest rate because you committed to an agreed-upon term. A typical CD term ranges from three months to five years. CDs often compound interest. So, the longer you leave your money in the CD, the bigger impact compounding has on what you earn.
Before opening a CD, ensure you don’t need access to your funds. Most CDs charge a hefty penalty if you take your money out early.
3. Money market accounts
Money market accounts (MMA) are savings accounts with checking account features. You write checks and make ATM withdrawals, but you may be limited to a certain number of transactions every month. Money market accounts may pay a higher interest rate than traditional savings accounts. If your money market account compounds interest, your balance grows quicker if you don’t withdraw funds.
4. IRA accounts
With an individual retirement account (IRA), you put funds away toward your retirement. Compound interest accelerates the growth of your IRA over time. Your interest payment gets added to your balance. The next time around, your earnings are calculated on a higher balance.
Retirement funds can stay in your account for years. Because the accrued interest generates earnings, compounding can significantly grow your IRA over time.
What you should look for in a compound interest account
Compound interest accounts have varying characteristics. Find the best compound interest account for your financial situation by considering the following:
1. Interest rates
Your interest rate is how much a bank pays to use your money. With a compound interest account, the interest rate is crucial when choosing an account. The higher the interest rate, the higher your earnings and the faster your balance grows.
2. Frequency of compounding
How often an account compounds interest determines what you earn. Compound interest accounts may calculate interest daily, monthly, quarterly, or annually. The more frequent the calculation, the more money you make.
A compound interest calculator lets you easily compare accounts that calculate interest on different schedules.
3. Minimum balance requirements
Some compound interest accounts require a minimum opening balance. Other times, you might be required to carry a minimum balance to get a more favorable interest rate.
4. Accessibility and flexibility
Consider your financial situation when seeking a compound interest account. CDs often pay a higher interest rate, but you can’t touch the money until the end of the term. You earn more interest but could be penalized if you take the money out before the period ends. A high-yield savings or money market account may have a lower interest rate, but you can withdraw the funds without penalty.
5. Additional benefits and features
If possible, choose a compound interest account held at a Federal Deposit Insurance Corp. bank. Your balance is protected for up to $250,000. If the bank goes under, you won’t lose that money.
Put your money to work with a compound interest account
With a compound interest account, your money works for you. As you earn interest, your balance grows.. Best of all, growing your savings with a compound interest account requires no extra effort.
FAQ
How often is interest paid out on a compound interest savings account?
Most compound interest accounts calculate interest every month. Some compound interest accounts may calculate interest every quarter or once a year.
Can I withdraw money from my compound interest savings account at any time?
Some compound interest savings accounts, such as high-yield or money market accounts, let you withdraw money at any time. With a CD or IRA, you could be charged a penalty if you withdraw early.
Is there a minimum balance requirement for a compound interest savings account?
While some compound interest savings accounts have minimum balance requirements, not every bank requires one.
