Calculating compounding interest can be a difficult concept to understand. Calculating how much interest a savings account will earn in a month involves many concepts like compound interest, annual percentage rate, annual percentage yield rate, etc. This article shows you how important it is to invest in the highest interest savings.
How do you calculate interest savings account?
The best way to learn how to calculate interest for a savings account is to do the math yourself. This article will look at how interest is calculated on savings accounts.
If we have $10,000 to put into our best rate saving account earning 5% interest, this interest will be compounded daily or monthly and credited to your account monthly.
Learning how to calculate savings account interest is important because it shows you how important compounding interest is. With an interest rate of 5%, we will earn 5% interest on our best rate saving account over 1 year. But, you will not be applying this 5% interest to only the initial $10,000 investment. Instead, your interest will be added to your account every day and you will get interest of 5% of you original deposit plus the already earned interest.
Let’s first calculate the interest that we will earn on our $10,000 during the year. If the high interest rate is 5%, we take 5/100 times the balance in your savings account ($10,000). Therefore $10,000 x .05 is $500. This means that if you were earning simple interest on your savings account, you would have $10,500 in your high interest account at the end of the year.
But high interest accounts don’t earn simple interest. They earn compounding interest. Now let’s determine how much interest you earn every day that in your high interest rate savings account.
So if you earn $500 in a year, you would divide $500 by 365 days which equals $1.37 a day. If you want to know the amoutn of interest you earn in a month, you divide $500 by 12 which equals $41.66 in interest.
But our best rate saving account earns interest on an annual basis, accrued daily, and paid monthly. There for if you see a bank advertising a high yield savings account with 5% interest this means that it will earn 5% over a year.
Now let’s try to understand compound interest that your savings account earns. In the example above we said that we earned $1.37 in interest on the first day. But, does it earn $1.37 every day? No because the best rate saving account interest is added to your account monthly. Every month the bank will pay you the interest you’ve accumulated in this month. This monthly payment is if there are 31 days in the month equal to 5/100 times $10,000 times 31/365 which equals $42.47 of interest. So after the first month of putting you money in your savings account your balance will be $10,042.47.
The next day, your bank will start accruing your interest earned again. So the daily interest will be 5/100 x 1/365 x $10,042.47. Because of compounding itnerest the interest next month will be higher than $42.47. This is the power of compound interest.
