Wondering how much you’ll earn monthly and yearly with the money in your savings account? Here’s what you need to know about how savings account interest works and how to calculate it.
What is APY?
Your savings account's annual percentage yield (APY) is the amount you’ll earn in interest yearly. The higher the APY, the more you’ll earn. APY accounts for compounding interest – interest you earn that’s added to the principal.
Simple vs. compound interest
Simple interest is calculated only on the principal amount, whereas compound interest is calculated on the principal amount and accumulated interest from previous periods. Interest may compound daily, monthly, quarterly or even annually. Savings accounts typically compound interest.
How is savings account interest calculated?
Simple interest is easy to calculate: Your interest is the principal multiplied by the interest rate multiplied by the time period.
For example, if you have $1000 in a savings account with an interest rate of 3% for 1 year:
$1000 (principal) * .03 (interest rate) * 1 (time period) = $30
However, most people want to understand compound interest when calculating how much they can earn on their savings account. Savings accounts typically earn compounded interest, or interest that builds upon itself and grows over time. Calculating compound interest is a bit trickier than calculating simple interest. You can calculate daily compound interest over the course of a year with the formula:
A=P(1+r/n)^nt
Where:
A = Final sum of interest and principal
P = Principal
r = Interest rate as a decimal value (for example: 2.00% would be 0.02)
n = Number of times interest is compounded in a time frame
t = Time frame
How much should you keep in a savings account?
How much you should keep in a savings account depends on your financial goals, as well as any monthly service fees you may be trying to avoid.
Common uses for savings accounts include:
- An emergency fund — Many experts recommend 3-6 months of savings in case of emergencies
- A vacation — Saving for an upcoming vacation can prevent credit card debt after the fact
- A major life event — Getting ready for a down payment? A wedding? A new addition to the family? All of these are great reasons to add to your savings.
You will want to keep a high enough balance in your account to avoid any monthly service fees, which are charged by some banks.
