The Truth About Compound Interest

Saving money is one of the hardest things to get into the habit of doing. It is even harder to enjoy saving when interest rates are so low. However there is something to always check for when investing and saving, look out for compounding. Compound interest occurs when interest is added to the principle. This means that your initial principle grows and now this bigger amount earns interest. This is called compounding.

XKCD Investing Compound Interest

Compounding may seem small and futile like in the hilarious example above by XKCD but it can mean a noticeable difference in savings accounts where compounding occurs quarterly versus daily. Most common bank accounts will only offer quarterly or monthly compounding however some credit unions will offer daily compounding if offered a choice always chose the account with the most frequent compounding.

For example $100 earning 2% interest compounded Yearly, Quarterly, Monthly, and Daily will yield the following amounts after 10 years.

Yearly Compound Interest:
Interest Earned: $21.90
Total Value: $121.90

Quarterly Compound Interest:
Interest Earned: $22.09
Total Value: $122.09

Monthly Compound Interest:
Interest Earned: $22.12
Total Value: $122.12

Daily Compound Interest:
Interest Earned: $22.14
Total Value: $122.14

As you can see after ten years had you gone with the daily compounding interest account you would have $.20 extra cents. With interest rates so low these days it is hard to see the value you in compound interest but if instead we took a $100 which earned 10% a year over the next 100 years we see quite a different story.

Yearly Compound Interest:
Interest Earned: $1,377,961.23
Total Value: $1,378,061.23

Quarterly Compound Interest:
Interest Earned: $1,947,708.05
Total Value: $1,947,808.05

Monthly Compound Interest:
Interest Earned: $2,113,141.46
Total Value: $2,113,241.46

Daily Compound Interest:
Interest Earned: $2,199,531.87
Total Value: $2,199,631.87

As you can see the value of daily compounded interest is extremely important as time goes on. The difference between the $100 yearly compounded and daily compounded is $821,570.64. In closing always be looking at how often your investment compounds when you are saving for the long haul and daily is always the best.