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What is compound interest

Saving money is a wise choice no matter what stage in life you are at. Of course when making such a responsible financial decision, you want to get the most out of your money. When you set up a savings account you will probably be met with a few different interest options – simple interest rates, compound interest rates, or period interest rates. Our savings calculator has two options to choose interest - it can be simple interest or compound. Compound interest is the best choice for savers because it rewards you for saving based on the amount you lodge into an account over time.

Compound interest savings can seem like a complicated system to get your hand around but it’s the most beneficial for those who want to put away money for a rainy day and watch their savings grow. The principal behind compound interest is that money builds up based on the original amount as well as on the interest gathered.

In effect, you save money, gain interest on that first lump sum, and then gain more interest based on the interest that is already there. It is a dual-stage system. It can be difficult to understand, so let’s imagine that you have started a savings account with the bank that offered you the best compound interest rates. The amount added to your savings will be determined via the following steps:

  1. You lodge a lump sum of money into the account, or pay in weekly.
  2. Interest applies to the amount at certain intervals of time, which will be decided when you start a compound interest savings account. The interest is calculated and added to the account.
  3. The interest is then compounded. This is an additional figure calculated from the amounts from steps 1 and 2. The frequency with which it is compounded will also be decided when you start the account.
  4. The more money you allow to remain in the account, the more you gain over time.

The amount of compound interest savings you can earn varies based on numerous factors:

  • The length of time you choose to save for – obviously a long-term savings account will earn more through interest than those with a short term goal.
  • The original amount lodged – the more you put in, the more that is paid back with interest.
  • The bank or institution you choose to save with – each will have its own compound interest savings rates.
  • The rate of inflation, which also affects the interest rates available to you.

In general, a compound interest savings account is the smart choice for anyone who wants a high return on their savings. The two-step calculation of interest means that savers can watch their account grow faster than it would with other kinds of interest and that can only be a good thing.