- 1). Calculate simple interest on a savings account. Interest is the percentage of your money the bank pays you on a yearly basis. If the interest rate is 4 percent and you put $1,000 in a savings account for a year, your money earns 4 percent of $1,000, or $40 per year.
- 2). Figure simple interest using average balance. Suppose you add another $100 to the $100 every quarter (3 months). As soon as it's deposited in your savings account, it starts earning interest. To calculate interest, you first find the average balance. Since your first additional $100 will be in the savings account 3/4 of the year, it adds 3 ($100), or $75, to the average balance. The next $100 is in your account for 1/2 year (adding $50 to the average balance), and the third $100 for 1/4 year (another $25). You end up with an average balance of $1,150. At 4 percent, you earn $46 interest.
- 3). Calculate interest compounded quarterly. When money is deposited in a savings account, the interest is calculated at periodic intervals, is added to your account, and starts earning more interest.
For example, let's say the $1,000 at 4 percent from Step 1 is compounded quarterly. The bank will pay 1 percent of the average balance at the end of each quarter. The first quarter you'll earn $10. But for the second quarter you will receive another $10 plus $0.10 (1 percent of the $10 added at the end of the first quarter) for a total of $20.10. The third quarter you earn interest on your $1,000 plus accrued interest, and the same for the fourth quarter. At the end of the year you will have received $40.61 instead of $40.00. - 4). Figure compound interest on average balance. In reality, the interest on most savings accounts is compounded daily. This is to your advantage because the more often the interest is compounded, the more it adds to your earnings. To calculate daily compound interest, start with the balance in the account each day. Multiply this by 1/365 of the annual simple interest rate, and add the result to the savings account.
To calculate daily compound interest for a year, you repeat this calculation 365 times. Because you use the actual balance for each day, any money added to the account automatically starts earning interest from the day it is deposited.
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