How to calculate interest earned on savings account
In today’s financial climate, it is essential for individuals to maximize their savings and ensure they are earning the most interest possible. One of the best ways to do this is by understanding how to calculate interest earned on a savings account. This article presents a step-by-step guide to help you gain a solid understanding of this important financial concept and make informed decisions about managing your savings in the future.
Step 1: Understand the terms
Before diving into calculations, it’s crucial to familiarize yourself with some key terms.
– Principal: The initial amount deposited into your savings account.
– Interest rate: The percentage at which your account will accrue interest, usually expressed as an annual percentage yield (APY).
– Compounding period: How often your interest is added to the principal – daily, monthly, or annually.
Step 2: Convert the annual interest rate
The first step in calculating interest earned on a savings account is converting the annual interest rate (APY) into a decimal form. To do this, simply divide the APY by 100. For example, if the APY is 2%, you would divide 2 by 100 to get 0.02. This number will be used in further calculations.
Step 3: Determine the compounding frequency
Next, determine how often your interest is compounded. The more frequently interest is compounded, the higher the overall return on investment will be. Common compounding frequencies include:
– Daily (365 times per year)
– Monthly (12 times per year)
– Quarterly (4 times per year)
– Annually (1 time per year)
Step 4: Calculate the periodic interest rate
Divide the annual interest rate (in decimal form) by the number of compounding periods in a year to find the periodic interest rate. For example, if your account compounds interest monthly and has an APY of 2%, divide 0.02 by 12 to get 0.00167.
Step 5: Calculate the total number of compounding periods
Multiply the number of years you plan to keep your money in the account by the number of compounding periods per year. For instance, if you intend to save for five years and your account has a monthly compounding period, multiply 5 by 12 to get a total of 60 compounding periods.
Step 6: Calculate interest earned
Now it’s time to calculate the interest earned using the formula:
Interest Earned = Principal * (1 + Periodic Interest Rate)^(Total Compounding Periods) – Principal
Substitute the values you’ve obtained in the previous steps into the formula. For example, if you started with a principal of $5,000, had an APY of 2%, compounded monthly for five years, your calculations would be:
Interest Earned = $5,000 * (1 + 0.00167)^60 – $5,000
Interest Earned ≈ $5,000 * (1.00167)^60 – $5,000
Interest Earned ≈ $5,000 * 1.1048 – $5,000
Interest Earned ≈ $5524 – $5,000 = $524
In this example, over five years with a 2% APY compounded monthly, you would earn approximately $524 in interest on your initial principal of $5,000.
By understanding how to calculate interest earned on a savings account and using this knowledge to compare different savings products and offers, you can make informed decisions about where to place your money for optimal growth and financial security