What is compound interest (and why should I care)?
23 May 2019
Compound interest can be one of those terms that you hear and think, “oh yeah, I know what that is. Everyone does!”. But when you actually try to explain it to someone? That’s when it gets tricky.
But it doesn’t have to be so complicated, and you can really benefit taking the time to wrap your head around it. By knowing what compound interest is, you can make smarter financial decisions which can potentially lead to better savings down the track. And who doesn’t want that?
Compound interest: a definition
Let’s start with your burning question; what on earth is compound interest, anyway? Basically, it’s 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.
This is different to simple interest, which 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 Everyday Options and eOptions account do. 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. But you also aren’t locked in and will usually have access to your money if you do ever need it.
Other benefits include:
- Compound interest is usually paid out more frequently, meaning that 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.
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 to make the most from your compound interest:
- Set your sights to the future. Not in a daydreaming-about-flying-cars type way (although feel free to do that too), but in an investments-take-time kind of way. 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.
- How to save your way to 1 million dollars
- 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 Product Information Document for Personal Deposit Accounts before opening an account. Fees, charges, terms and conditions apply and are available upon request.