How to Calculate the Interest Rate on Savings Accounts

Interest rates are more meaningful once you understand how they translate to dollars in your pocket. Running the numbers can tell you the financial gain you can expect when you put your money in a particular account.

How to Calculate the Savings Rate

Interest can be calculated in two ways: simple interest and compound interest. To calculate simple interest, use the formula a = r*t*p or a is the total amount of interest you will earn, r is the rate, you is the period, and p is your principal (account balance). Remember that percentages are expressed as two (or more) decimal places (2% is 0.02 and 2.5% is 0.025) and when we talk about an interest rate annual, the period is one year.

For example, if you have $1,000 in an account that earns 1%, the formula is

a = 0.01 × 1 × 1000

a = 10 (this is the number of dollars you will earn)

Simple interest is easy to calculate and can give you a good idea of ​​how much you will earn. But with a savings account, you’ll actually earn a bit more. Indeed, savings accounts pay interest more than once a year. Instead of simple interest, you’ll earn compound interest, and it’s a better deal for you.

How to Calculate Compound Interest

Depending on how savings accounts work, interest is calculated more frequently than once a year. Each time it is calculated, interest is added to your balance. The next time interest is calculated, you have a larger principal balance to use in the equation.

Using the same example, let’s say the interest is compounded monthly. This means that instead of earning 1% per year, you earn one-twelfth of one percent per month.

a = 0.083 × 1 × 1000

After a month, you will have $1,000.83.

It’s better now. In the second month, you will earn the same 1/12%, but you can multiply it by the higher balance:

a = 0.083 x 1 x 1000.83

At this point, you are already earning interest on your interest. Your balance at the end of the second month is $1,001.67, which is one penny more than you would have earned with simple interest on the same amount.

If you leave that money in the bank for 10 years and the rate doesn’t change, you’ll have $1,104.20. Conversely, if you put the money in an account that pays simple interest, the balance will only reach $1,100 in the same amount of time.

The more money you put in your savings account, the more important it is whether the account earns simple or compound interest. Compound interest will help you reach each savings goal faster. The vast majority of savings and money market accounts pay compound interest. Some certificates of deposit (CDs) earn simple interest.

APY savings account

When you see the interest rate for a savings account, you’ll likely see the letters APY next to the rate. This represents the annual percentage return. It’s a way to show you how much you’ll earn after composition is taken into account. APY is always a bit higher than the interest rate. If the APY is 1%, the annual interest rate is approximately 0.9901%.

You can calculate your APY savings account with the formula APY = (1 + r / n)n or r is the interest rate and not is the number of compounding periods that occur in a year (12 if interest is paid monthly, 365 if interest is paid daily). To calculate APY based on daily compounding, you will need to use a calculator that can handle high exponents.

How to Get the Best Savings Account Interest Rates

Maximizing the amount of interest you get on your savings is one of the easiest financial challenges you can face. That’s because unlike checking accounts and credit cards, there aren’t many bells and whistles to compare on savings accounts. Identify the best savings account and apply. It’s your money. Switch banks if you qualify for a more lucrative offer.

Critical factors to weigh include:

Interest rate: A high-yield savings account earns more than a traditional savings account.

Costs: Avoid paying monthly maintenance fees as this decreases your revenue.

To access: Most people’s needs are met with online access, but it may take a day or two for the transferred funds to reach your checking account if that account is at another financial institution. For immediate access anytime, find a savings account that comes with a debit card and free ATM withdrawals near you.

Alternative account types: A money market account combines the convenience of a checking account with the higher earning potential of a savings account. Not all money market accounts pay high interest. A certificate of deposit account often pays as much as or more than a high-yield savings account, but you won’t be able to access the money for a period of time (usually anywhere from one month to five years). Early withdrawals may be subject to penalties.

Saving money is something you can be very proud of. Reward yourself for that effort by finding the account that will make your money work as hard as you do to grow your wealth.

Stephen V. Lee