The greatest thing about a savings account is the fact that you get to earn money on your existing money without doing any work. The money that you earn is called interest. The money that you put in your account is called principal. One important concept to remember is that not all interest is the same.
There are two different types of interest. The first type is called simple interest and the second type is called compound interest. Both types of interest will earn you money but they work in very different ways.
Simple Interest is calculated based on the amount of your deposit – or the principal amount. As an example, if you put $200 in a savings account for a 2 year period and the bank agrees to pay you 12% simple interest, you will have earned $48 in interest at the end of the two year period. This will give you a total balance of $248.
Here is the basic formula for simple interest:
- Deposit * interest * period
Here is the simple interest formula using the example above:
- $200 * 12% * 2 = $48
Compound Interest is a little bit more complex than simple interest. Compound Interest is calculated based on the amount of your deposit – or the principal amount – and the amount of interest previously earned. The interest can be determined (or compounded) at different intervals such as annually, daily, quarterly or twice a year. The more often it is compounded, the more you will earn. Compounded interest will earn you more money than simple interest.
The formula for calculating compounded interest is a bit more complicated. It is much easier to take advantage of a calculator in order to determine your earnings.
Here is a compound interest calculator that will determine the amount of money earned if the interest is compounded annually.
