What is compound interest (and why should I care)?
21 September 2022
Compound interest is the interest you earn on your savings while it’s sitting in the bank – not just on the original amount of money you deposited, but also on the interest you have been paid as you go. Yep, that’s interest earned on interest, you read correctly.
How does it work
Compound interest can be a powerful way to save money in the long term. Why? Because the amount of money you accumulate interest for increases exponentially. This means your interest rate is applied to your original deposit amount as well as any interest you’ve accumulate so far. Every month of accrued savings from interest is larger than the last (as long as you haven’t withdrawn any). If you then regularly contribute to these savings, they can grow rapidly.
The best way to think about compound interest is by imagining a snowball. A snowball consistently grows larger as it accumulates snow on the way down a big hill. That’s how compound interest works – it gets ever larger by building on the wealth it has developed so far.
Compound interest vs simple interest
Simple interest is only applied to the principal (original) deposit at the end of a certain period of time, or ‘term’. That’s standard in term deposits. It allows you to store your money away at a locked-in interest rate. It also takes away your temptation to spend it, and rewards you with a guaranteed return when the term ends.
Most savings accounts, on the other hand, offer you compound interest – like Suncorp’s Growth Saver Account. The main benefit of this is that you will continue to earn interest on all your savings the longer you keep your funds stored in your account. Earn bonus interest every month you grow your net balance by $200 or more (excluding interest) and make no more than one withdrawal.
This graph shows the potential difference over time between compound interest and simple interest. Both examples begin with $5,000 and have no money actively added to them (apart from interest) over the course of the 30 years.
What are the benefits of compound interest?
- Compound interest is usually paid out more frequently, meaning you could potentially see interest added to your account every month (this differs between accounts, so it’s important you double check this for yourself).
- If you have to close your account or transfer your funds, for whatever reason, compound interest is usually calculated that day. That means it’ll still be added to your savings.
- There’s usually no minimum amount needed to start earning interest.
- To help you save faster, we’ve removed account keeping fees on all Suncorp personal and business deposit accounts – forever!
How to make the most of compound interest
You can apply the same advice that your friends might have used after your last breakup when it comes to compound interest – it takes time. It can be an effective way to earn money on top of your money, but it’s certainly no get-rich-quick scheme.
If you realise the benefits of compound interest early in life, you’re more likely to reap the rewards later. It’s not just about getting a head start on the game, though – there are other things you can do to make the most from your compound interest:
- Set your sights to the future. If you can get into the mentality that the longer your money earns compound interest, the better, you won’t expect to reap the benefits within days or even years. But in a couple of decades? You’ll more than likely be thanking your younger self.
- Be savvy with your spending. One of the pitfalls of using a savings account to earn compound interest is, of course, how easy it is to access your money. While expecting to never spend any of your money is a bit of a stretch, you can be minimise your impact on your savings, by setting a budget, and keeping a separate, high-interest earning account for your savings that you try not to touch at all. You can also set up automatic transfers between your savings account and everyday transactions account. That way, your money stays in your savings account, earning interest at a higher rate for as long as possible.
- Pay attention to interest rates. Many savings accounts offer a standard rate paid on your whole balance, no strings attached, and a bonus rate that you’ll only get if you meet certain criteria. For example, with Suncorp’s Growth Saver Account, you can earn your bonus rate simply by growing your net balance (excluding interest earned) by at least $200 every month, and making no more than one withdrawal each calendar month. Talk about an incentive for not touching your savings and helping that compound interest grow!
- Decide if a term deposit or savings account is better for you. Only you can determine whether a term deposit or regular savings account will work best for you. Maybe you’re someone who needs your money to be out of sight, out of mind to ensure you don’t spend it. It’s important to carefully weigh up the pros and cons when deciding between a savings account or term deposit.
Enjoy guaranteed savings growth with Suncorp
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- How to set up a personal budget plan
- 4 simple ways to keep track of your spending
- Bucketing your money - the better way to save and spend
Information is intended to be of a general nature only and any advice has been prepared without considering any person's particular objectives, financial situation or needs. Deposit Products are issued by Suncorp-Metway Limited ("Suncorp Bank") ABN 66 010 831722 AFSL No 229882. Please read the relevant Product Information Document and Terms & Conditions before opening an account.