What is interest?
Interest is probably the easiest money you will ever earn. All you have to do is leave your money in a savings account and the bank will add a specified percentage of interest to your account.
Most bank accounts earn compounded interest, which allows your money to grow at an accelerated rate. Interest is paid on the balance in your account, including any previously earned interest. Bank accounts may compound interest at different intervals, such as daily, monthly or annually.
You’ll see the interest rate paid on an account expressed as an interest rate and as an annual percentage yield (APY). The interest rate is the rate of interest your money will earn, without considering any compounding of interest within that year. The APY is the annual rate of interest your money will earn in one year, taking into consideration the compounding of interest. Compounding more frequently will yield more interest on your money, that’s why it’s important to use the APY when comparing savings accounts.
Let’s look at an example of the power of compound interest.
This chart assumes an initial deposit of $1,000 and a 5% interest rate compounded annually.