Description

• When you deposit money into a savings account, the bank agrees to pay you interest. Interest is a proportion of the money in your savings account, usually expressed as an annual percentage rate, or APR. The APR is based on the assumption that interest is calculated and added to your account once a year. In practice, banks figure interest and add the money earned to your balance several times a year -- a practice called compounding.
  
  

Types

• Banks and credit unions offer several popular types of savings accounts. Regular savings accounts feature low minimum deposits and allow you a limited number of withdrawals without penalizing you. However, regular savings accounts tend to pay the lowest interest rates. Certificates of deposit, or CDs, are time deposits. This means you deposit a specific amount of money and agree to leave it in the account for a stated period of time or pay a penalty. Banks pay higher interest rates on CD deposits. Bank money market deposit accounts usually pay an interest rate between those offered on regular savings accounts and CDs.
  
  

Compounding

• The idea behind compounding is simple enough. When you compute the interest earned and add it to the balance in your account, the added money starts earning more interest. The more often you compound interest, the more you increase the yield. Most savings accounts are compounded daily. That's not always the case, however. To make certain, ask your banker what the terms of a particular savings account are.
  
  

Formula

• There's a standard formula to calculate compound interest. Call the annual percentage rate A and the balance in the savings account B. N is the number of times each year interest is compounded (for daily interest, that's 365). E is the interest earned. The formula is E = B(1 + A/N)^N -- B. The "^N" symbol means N is an exponent, so you multiply the quantity inside the parentheses by itself N times. If you have a savings account that is compounded monthly instead of daily, set N equal to 12 instead of 365.