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When you earn interest in a savings account, the bank is literally paying you money to keep your cash deposited there.
Savings accounts earn compound interest, which means the interest you earn in one period gets deposited into your account, and then in the next period, you earn interest on that interest. Calculating exactly how much interest your deposits earn over time requires accounting for compound interest — we’ll get into that later on — but you can start by getting a reasonably accurate estimate using the simple interest formula.
You can calculate simple interest in a savings account by multiplying the account balance by the interest rate by the time period the money is in the account.
Here's the simple interest formula: Interest = P x R x N.
P = Principal amount (the beginning balance).
R = Interest rate (usually per year, expressed as a decimal).
N = Number of time periods (generally one-year time periods).
Say you have a savings account with $10,000 that earns 1% interest per year. Expressed as a decimal, the interest rate is 0.01, so the formula would be:
Interest = $10,000 x 0.01 x 1, which equals $100.
Interest rates in even the are lower than 1%, however. In fact, the national average savings rate is . You can use to figure how much interest you could earn with different rates and time periods.
Here’s another example: If the $10,000 deposit is in an account that earns only 0.10% interest per year, the interest rate would be expressed as 0.001. In this case, the calculation would be:
Interest = $10,000 x 0.001 x 1.
Interest = $10.
Practically speaking, this formula is best for calculating roughly how much interest your money can earn in a savings account.
To determine precisely how much interest you could earn in a savings account, you’ll want to consider the effect of compounding.
If you're earning interest in a savings account, that interest will also earn interest over time. This process is called compounding, and your overall earnings will be a bit higher than what’s calculated with the simple interest formula.
Suppose your account has earned $10 in interest. If you leave that extra bit of money in your account, it will also start earning interest during each compounding period (many compound daily). Compound interest helps your bank balance grow faster over time, even if the interest rate is low. The rate of compounded interest earned over a year is expressed as the annual percentage yield, or APY.
Say you have $10,000 in a high-yield savings account that earns 0.50% APY, and you keep the money in the account for five years. Using the simple interest formula (Interest = $10,000 x 0.005 x 5), you can see that your simple interest would be $250.
But if interest is compounded daily, you’d earn about $254. The difference may not be huge when interest rates are low, but this is added money with no additional effort on your part. The higher the rate, the more your interest will grow. In addition, the more compounding periods there are, the more interest grows.
You can use and select the compounding period (daily, monthly or annually) to determine how much you could earn in other scenarios.
The compound interest formula is more complicated than the simple interest formula, but it provides more accurate results for saving money over time. However, the simple interest calculation is good for a quick estimate.
» Want to dig deeper? Read this .
Compound interest is a good way to have your money work for you, but you can really boost your savings if you take the additional step of making regular savings deposits. Additional deposits help you grow your account balance more than with interest alone. In the example above, say you deposit an extra $100 a month after the initial $10,000. In five years at 0.50% APY, your balance grows to about $16,330.
It’s worth noting that interest rates in savings accounts are variable and can change at any time. If you would like to deposit your money in an account with a fixed rate, consider a high-performing .
To earn more interest, you’ll need to put your money in an account with a strong interest rate. Many online banks tend to have savings accounts with above-average interest rates. Check out this list of the to see how they compare.