Compound interest and your savings account

How can compound interest help you grow your savings?

Compound interest can turn a small amount of money today into a large amount of money over the space of 10, 20 or 30 years.

The longer your timeline ahead of you, the more you stand to benefit from compound interest.

How do banks calculate compound interest?

Interest is typically calculated on the daily closing balance. Here's the savings account equation:

• Daily closing balance x interest rate (as a percentage) / 365

Interest begins to accumulate on the day the opening deposit is made in your savings account. It's then usually credited into your account on the last day of each month. If you choose to close your account, your accrued interest will be deposited on the day it's closed.

Any interest awarded to your savings account is usually available for use on the same day it's been credited. The daily closing balance of your savings account tends to include all cleared and uncleared transactions. This may be because electronic transfers to your linked bank account usually occur on a business day.

Our expert says

"I would almost always put money into a savings account over a term deposit. Savings accounts earn compound interest (meaning you earn interest on the interest paid), whereas most term deposits only earn simple interest (meaning you earn interest only on the initial deposit)."

Alanna Glenn

Publisher

How do you find the monthly interest rate?

The monthly variable interest rate will be clearly displayed on the provider's website under the product description for the particular account you’re looking at. Instead of going to each bank's website, you can take a look at the latest high interest savings account interest rates in our guide. It is important to remember that the interest rate is variable, meaning it will change from time to time.

Frequently asked questions

• How can I tell if a savings account pays compound interest?

  Savings accounts in Australia pay compound interest. But to help you compare between types of products, you will want to first look at when interest is paid, and then where. Interest that is paid monthly into the savings account will be compounded.

  However, on some term deposits for example, you can choose to have monthly interest payments, but these are paid into your linked account, not added to your balance, meaning you earn simple interest.

• If my savings account requires a minimum monthly deposit, will my earned interest count towards that?

  In most instances no, the minimum monthly deposit requirement must be met with other money deposited in the account. For instance, if the account requires a deposit of $150 and you have a balance of $100,000, the interest deposited for the month will be $166.66. This usually will not count towards your minimum deposit, and you'll need to transfer money in from another external account to meet this requirement.

• Will my interest earnings be taxed?

  Yes, banks are required to withhold tax on your interest earnings. The amount depends on your personal circumstance. To avoid having tax withheld at the highest marginal rate, you should always include your tax file number (TFN) and exemption codes on your application.

• How can I make the most out of the interest on my savings account?

  To help grow your savings, regularly deposit money into the account and allow time for your savings to grow. The longer your money is in the savings account, the more money you'll earn.

• How else can I earn compound interest?

  Compounding can be found with a number of different financial products. One example is investments, including via your superannuation. Instead of earning interest, you earn compounded investment returns. This is why investing a small amount early on in life is so beneficial - it can grow to a lot more over time through the power of compounding.