Create your very own Auto Publish News/Blog Site and Earn Passive Income in Just 4 Easy Steps
Earn interest on your savings. Sounds great. But how does the interest formula for a savings account actually work?
While building an investment portfolio is often a key element in growing your money, using an interest-bearing savings account is also a valuable part of sound financial planning.
When you start saving, you naturally wonder how much your money can grow over time based on simple and compound interest.
We'll introduce you to some savings account interest formulas to help you figure out how much you can earn.
Simple interest formula for a savings account
If you want to know how much simple interest you will receive on a savings account, you need to multiply your account balance by the term of the funds in the account and the interest rate.
Here is the formula: Simple interest = P x R x T
The formula contains the following variables:
- P – Represents the principal amount, also called the beginning balance.
- R – Represents the interest rate expressed as a decimal.
- T – Represents the number of time periods.
The following example can help you put these variables into context.
How to calculate simple interest on a savings account: Example
Suppose you deposit $20,000 into a savings account that earns 5% interest per year. Expressed as a percentage, the interest rate is 0.05. You plan to leave the money untouched for a year.
Here is the formula:
Simple interest = $20,000 x 0.05 x 1 = $1,000
If the savings account only paid 1% interest, it would look like this:
Simple interest = $20,000 x 0.01 x 1 = $200
Simple interest vs. compound interest
The simple interest formula provides an estimate of how much you can expect to earn over a given period of time. However, to get a more accurate estimate of the amount of interest you will earn, you must take compound interest into account.
Compound interest works by giving you interest on interest you've already earned. Over time, the amount you earn increases because of the interest already added to your account balance.
Generally, compound interest is expressed as an annual percentage rate (APY).
Compound interest formula for a savings account
Most savings accounts are based on compound interest, meaning you earn interest on your interest.
Here is the formula: Compound interest = P (1 + (r/n)) ^nt
For this formula we use the following variables:
- P – represents the capital amount, also called the initial balance
- R – represents the interest rate as a decimal number
- T – represents the number of periods, usually in years
- N – represents the number of compound interest per year
Below is an example to help you put these variables into context.
How to calculate compound interest on a savings account: Example
Suppose you deposit $20,000 into a savings account that pays 5% annual interest. The interest is compounded monthly. Expressed as a percentage, the interest rate is 0.05. You plan to leave the funds untouched for two years.
Interest = 20,000 (1 + (0.05/12))^(12 x 2)
Interest = $2,098.83
If you left the funds untouched for longer, the interest would continue to rise. For example, let's say you let the funds grow monthly at an APR of 5% for five years. That's how much you could earn.
Interest = 20,000 (1 + (0.05/12))^(12 x 5)
Interest = $5,667.17
Other free interest calculators
If you don't want to put pen to paper, that's fine too. You can use one of the many free online calculators to determine your interest income.
Investor.gov, for example, offers a compound interest calculator to make your calculations easier.
How to get the most out of your savings
If you want to put your savings to work for you, check out our list of the best high-interest savings accounts. Depending on market conditions, you may have different interest rates available to you. Of course, it's usually a good idea to secure the highest rate possible.
If you'd rather lock in a potentially higher interest rate for a set period of time, a certificate of deposit (CD) may be a better choice. Many CDs offer attractive interest rates for savers, and it can pay to shop around.
The conclusion
Smart savers can work out how much interest they can expect by doing a few calculations themselves or entering their own numbers into a ready-made calculator. They can also use the numbers to motivate themselves to save more money for the future.
Create your very own Auto Publish News/Blog Site and Earn Passive Income in Just 4 Easy Steps
