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When you earn interest in a savings account, the bank is literally paying you money to keep your cash deposited there.
Savings accounts earn compound interest, which means the interest you earn in one period gets deposited into your account, and then in the next period, you earn interest on that interest. Calculating exactly how much interest your deposits earn over time requires accounting for compound interest — we’ll get into that later on — but you can start by getting a reasonably accurate estimate using the simple interest formula.
How to calculate interest in a savings account
You can calculate the simple interest you’ll earn in a savings account by multiplying the account balance by the interest rate by the time period the money is in the account. Note that the interest in a savings account is money you earn, not money you pay.
The formula for calculating simple interest is: Interest = P * R * T.
P = Principal amount (the beginning balance).
R = Interest rate (usually per year, expressed as a decimal).
T = Number of time periods (generally one-year time periods).Say you have a savings account with $10,000 that earns 4% interest per year. Expressed as a decimal, the interest rate is 0.04, so the formula would be:
Interest = $10,000 * 0.04 * 1, which equals $400.
Interest rates in the best savings accounts are above 4%. But other accounts earn much less. In fact, the national average savings rate is 0.47%. You can use NerdWallet’s savings calculator to figure out how much interest you could earn with different rates and time periods.
Here’s another example: If the $10,000 deposit is in an account that earns only 0.15% interest per year, the interest rate would be expressed as 0.0015. In this case, the calculation would be:
Interest = $10,000 * 0.0015 * 1.
Interest = $15.
Practically speaking, this formula is best for calculating roughly how much interest your money can earn in a savings account based on the principal balance.
To determine precisely how much interest you could earn in a savings account over time, you’ll want to consider the effect of compounding.
» Ready to earn interest? Learn about the best places to save money and earn interest
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Savings account simple interest vs. compound interest
If you're earning interest in a savings account, that interest will also earn interest over time. This process is called compounding, and your overall earnings will be a bit higher than what’s calculated with the simple interest formula.Suppose your account has earned $10 in interest. If you leave that extra bit of money in your account, it will also start earning interest during each compounding period (many online savings accounts compound daily). Compound interest helps your bank balance grow faster over time. The rate of compounded interest earned over a year is expressed as the annual percentage yield (APY). You will typically see savings account rates expressed as an APY.
🤓Nerdy Tip
The Federal Reserve raised rates to the highest levels in more than two decades, which is good news for your savings accounts.
How much interest will I earn on $10,000?
Say you have $10,000 in a high-yield savings account that earns 4% APY, and you keep the money in the account for five years.
If interest is compounded daily, you’d earn about $2,214. Compare that with earning only simple interest and no compounding: Using the simple interest formula (Interest = $10,000 x 0.04 x 5), you can see that your simple interest would be $2,000.
With compound interest, you get additional money with no additional effort on your part. The higher the rate, the more your interest will grow. In addition, the more compounding periods there are, the more interest grows.
You can use NerdWallet’s compound interest calculator and select the compounding period (daily, monthly or annually) to determine how much you could earn in other scenarios.
You can know how banks calculate interest on savings accounts by understanding the compound interest formula. It’s more complicated than the simple interest formula, but it provides a more accurate result for saving money over time. However, the simple interest calculation is good for a quick estimate.
The compound interest formula
Here is how to compute monthly compound interest for 12 months: Use the formula A=P(1+r/n)^nt, where:
A = Ending amount.
P = Principal amount (the beginning balance).
r = Interest rate (as a decimal).
n = Number of times interest is compounded in a specific time frame.
t = Time frame.
» Want to dig deeper? Read this primer on compound interest
Compound interest is a good way to have your money work for you, but you can really boost your savings if you take the additional step of making regular savings deposits. Additional deposits help you grow your account balance more than with interest alone. In the example above, say you deposit an extra $100 a month after the initial $10,000. In five years, you would have deposited an extra $6,000 ($100 * 12 months a year * 5 years = $6,000). But when compounded daily at 4% APY, your balance grows to about $18,845.
You don’t need to have $10,000 to take advantage of compound interest
Suppose you start with a $0 savings balance and make savings deposits on a regular basis. For example, say you set aside roughly $20 from each paycheck and then deposit $40 each month into your savings account. Since there are 12 months in a year, you would have deposited $480 ($40 * 12 months = $480). Continue doing that for five years, and you would have made $2,400 in deposits ($480 * 5 years = $2,400). But if that money is in a savings account that earns a 4% APY over the entire term, compounded daily, the account balance would be $2,652.
So your money would have earned you an extra $252 all from starting with zero and saving $40 a month on a regular basis.It’s worth noting that interest rates in savings accounts are variable and can change at any time. If you would like to deposit your money in an account with a fixed rate, consider a high-performing certificate of deposit.
How to earn more interest in a savings account
To earn more interest, you’ll need to put your money in an account with a strong interest rate. Many online banks tend to have savings accounts with above-average interest rates. Check out this list of the best high-yield online savings accounts to see how they compare.
