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Online Financial Literacy Workshop
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What is compound interest (APY)?
In a savings account your money can grow because it earns interest. And the rate at which your money grows depends on how that interest is compounded. Another important thing to think about when using a savings account is the Annual Percentage Yield, or APY. APY is the amount of interest you will earn on a yearly basis expressed as a percentage. It includes the effect of compounding.
| Most savings accounts compound interest on your balance. That means you earn money on the interest you leave in your account. For example, if you have an account that compounds interest annually, by the end of |
one year, you will have earned $50 bringing the total in your savings account to $1,050. That's $50 more than if you left the $1,000 under your mattress for a year. Interest can be compounded daily, monthly, or annually.
Take a look at this chart. Even small amounts of savings add up. Look at what happens when you just save $1 a day with compound interest. At the end of one year, you will make only an extra $9 compounding interest. But the real power of compounding shows over time. Look at how much your money grows at the end of 30 years. You've made an extra $14,465. Now look at what happens over |
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| the same period of time if you save just $5 a day. At the end of one year, there's only a difference of $46, but if you compound daily for 30 years, there's difference of $72,327. |
How does compound interest work?
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Annual Compounding |
Daily Compounding |
| Start with; $1000 at 5% compounded Annually |
Start with; $1000 at 5% compounded Daily. |
| At the end of the 1 st day; still $1000 |
At the end of the 1 st day ; Now have $1000.14 |
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Second day add interest earned and compound that amount ($1000.14) |
At Years End; $1050
$50 or 5% of $1,000 added to original deposit. |
At Years End; $1,051.27
Compounding each day's interest earned and $1,000 |
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If you deposit $1000 into a savings account that compounds annually, at the end of one year you'd have $1050. Now say you deposit that $1000 into a savings account that compounds daily, at the end of the first day you would have $1000.14. The next day the interest is calculated based on the entire amount of your original deposit of $1000, plus the previously earned interest which is the $1000.14 amount. At the end of one year you'd have $1051.27. The $1.27 figure may not seem like much at this point, but it will make a difference over time.
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