In the long run, you'll make more money by reinvesting the savings account interest and the initial investment. It's called compounding, when you get Interested in your savings and Interest on the Interest you've accrued from previous periods.

To generate money, investors might use the compound interest principle. Savings account interest is often expressed as a percentage. If you do have $1,000 in the bank, for example, you might get 1% interest. Due to low-interest record rates, many banks give less than 1% return on savings accounts.

Interest on Interest

A simple calculation of Interest reveals that a sum of $1,000 invested for one year and achieved a return of 1 per cent would result in the accumulation of $1,010 (or 0.1 times 1,000) by the maturity date.

However, this estimate is based on simple Interest, which is Interest that is paid just on the principal or the money deposited. It's possible that confident investors, such as pensioners, will cash out the Interest they've earned or move it to a different account.

The interest payments are a source of revenue for the individual. If the Interest is taken out of the account, the depositor's account will only earn simple Interest because no interest will be earned on any interest earned in the past.

However, because interest rates are so low, many people who deposit money into savings accounts may choose to let the Interest they earn remain in their accounts. Because of this, the funds in the bank account would accrue compound interest, an interest rate determined by taking into account both the initial deposit and all of the Interest that has previously been earned.

The Power Of Compound Interest

Compounding can occur daily, monthly, or quarterly in savings accounts. When this occurs, you accrue Interest on the Interest you have already earned up to that point. Your savings will increase faster according to the frequency with which profit is added to your balance.

When we apply daily compounding to our earlier example of $1,000 and expand the amount of Interest earned daily, it results in an increase of another 1/365th of 1 per cent. The amount has increased to $1,010.05 by the end of the year instead of growing by $110 through simple Interest.

Even while an additional $0.05 doesn't sound like much, after ten years, your $1,000 would have grown to $1,105.17 thanks to compound interest if you had invested it. Because of the daily compounding of the one per cent interest rate for ten years, the value of the investment has increased by more than ten per cent.

Again, the amount generated may not seem like, but think of what would occur if you could put away one hundred dollars per month and add that to the initial deposit of one thousand dollars.

You would have earned a total of $16.05 in Interest after one year, bringing the total amount to $2,216.05. After ten years, if you continued to put aside only $100 each month, you would have accumulated $725.50, bringing your total to $13,725.50.

Snowball Effect

Consider this famous experiment by Benjamin Franklin to grasp compound interest's snowball impact fully. He was a showman, so launching an experiment that would not yield results for 200 years after his death in 1790 would have given him a laugh.

In his testament, Franklin bequeathed approximately $4,500 to each of Boston and Philadelphia. For the next 100 years, he instructed that it should be invested at a rate of 5% every year. The rest of the money was reinvested for another 100 years, with three-quarters going to a worthwhile cause.

Due to compound interest's effects, Boston's fund had $4.5 million in 1990, while Philadelphia's fund had $2.5 million. Franklin predicted a total of $21 million for the two cities, but none came close. Since rates fluctuate over time, Franklin's 5 per cent annual rate is unlikely to be achieved.

Start Early, Save Often

Nevertheless, Franklin's experiment showed that compound Interest could generate wealth over time even at historically low-interest rates. Going online is the best way to find banks' current interest rates.

High-yield savings accounts are a speciality of several financial institutions. Interest compounded daily and monthly fees are not included in the most acceptable savings accounts, which can be found at institutions that provide such accounts.

Compounding is reflected in the annual percentage yield (APY) that banks commonly use to express their interest rates. There is a difference between APY and APR because APR does not incorporate compounding.

Long-Term Benefit of Compounding

The notion of compound Interest is one that investors can use to their advantage to increase their savings and, ultimately, their riches. You will increase the amount of money you have in your savings account over the long run by reinvesting the Interest you have gained on your savings account and the initial amount you have put in.