Monthly interest accounts: How does monthly interest work?

Saving money is an essential aspect of financial planning, and understanding how interest accrues on savings accounts is key to maximizing your savings potential.

So, let’s dive into the intricacies of monthly compound interest on savings accounts together. From calculating monthly interest to comparing monthly and annual compounding, we'll equip you with the knowledge needed to make informed decisions about your savings.

Monthly compound interest is the interest calculated and added to your monthly savings account balance based on the principal amount and interest rate. Unlike simple interest, which is calculated solely on the initial deposit, compound interest considers both the initial deposit and accumulated interest.

Other types of compound interest include annual, semiannual, quarterly, or even daily. Savings products on the Raisin platform typically feature daily compounding interest.

Monthly interest works by calculating and adding interest to your savings account balance every month. This process involves the compounding of interest, where the initial deposit and accumulated interest earn additional interest over time. Here's a breakdown of how monthly interest works:

• Initial deposit: When you open a savings account, you deposit an initial amount known as the principal.
• Interest rate: The bank or financial institution sets an annual interest rate, which determines the percentage of interest earned on your savings each year.
• Calculation: With monthly interest, the annual interest rate is divided by 12 to determine the monthly interest rate. This monthly interest rate is then applied to your account balance each month.
• Compounding: Each month, the interest earned on your account balance is added to the principal. As a result, future interest calculations are based on the updated balance, including both the initial deposit and the accumulated interest.
• Continuous growth: Over time, the compounding effect leads to exponential growth in your savings. The more frequently interest is compounded, the faster your savings will grow.
• Regular payouts: Depending on the terms of your savings account, you may receive interest payments monthly, allowing you to enjoy a steady stream of income from your savings. Keep in mind that withdrawing accrued interest prevents it from compounding further.

A monthly compound interest savings account, also known as a monthly compound savings account, calculates and adds interest to your account balance monthly using the principle of compound interest. This type of account adds the interest earned each month to the principal. Subsequent interest calculations are based on the updated balance, including the initial deposit and the previously earned interest.

Here are some key features and benefits of a monthly compound interest savings account:

• Frequency of compounding: In a monthly compound interest savings account, interest is compounded each month. This means that your savings grow at a faster rate compared to accounts with less frequent compounding periods. It will also grow at a slower rate compared to accounts with more frequent compounding periods, such as a daily compounding interest account.
• Accelerated growth: The compounding effect leads to exponential growth in your savings over time. Since interest is added to your account balance more frequently, your savings accumulate faster, helping you potentially reach your financial goals sooner.
• Consistent earnings: With monthly compounding interest, you can expect a regular stream of interest income added to your account each month. This provides a predictable source of passive income, which can be beneficial for budgeting and planning purposes.
• Flexibility: Many monthly compound interest savings accounts offer flexibility in terms of deposit and withdrawal options. This means you can access your funds when needed without sacrificing the benefits of compounding interest.
• Competitive rates: Some financial institutions offer competitive interest rates on monthly compound interest savings accounts, allowing you to maximize your earnings potential.

Calculating monthly interest on a savings account involves a formula that may appear daunting, but is actually pretty straightforward:

Where:

• A = the future value of the investment/loan, including interest
• P = the principal investment amount (the initial deposit or loan amount)
• r = the annual interest rate (in decimal)
• n = the number of times that interest is compounded per unit of time (for example, 12, for monthly compounding interest)
• t = the time the money is invested/borrowed for in years

For example, if we consider an initial deposit of $100,000 (P) at a 3.00% interest rate (r) compounding monthly (n = 12) held for 1 year (t), the formula would be as follows:

In this case, the future value would be $103,041.60, with $3,041.60 being the interest earned on top of the principal of $100,000. 

• Faster growth: Monthly compounding accelerates the growth of your savings compared to simple interest or less frequent compounding periods.
• Increased earnings: With monthly compounding, your savings account earns interest on interest more frequently, leading to higher overall earnings over time.
• Smoothing volatility: Monthly compounding can help mitigate the impact of market fluctuations on your savings by spreading the effects of interest rate changes.

While both monthly and annual interest accrual methods have advantages, understanding their differences is crucial for making informed financial decisions.

• Frequency of compounding: Monthly compounding involves interest calculations and additions every month, whereas annual compounding does so once a year.
• Impact on earnings: Monthly compounding typically results in higher overall earnings due to more frequent interest additions. However, the difference may be marginal for lower interest rates or shorter investment periods.
• Accessibility of funds: Savings accounts that compound interest monthly may offer more frequent access to accrued interest, providing liquidity when needed compared to accounts with annual compounding.

Some accounts allow for daily compounding interest, such as most of those offered through the Raisin platform. Here is how they differ:

• Frequency of compounding: With daily compounding interest, interest is earned on the principal each day (although may only post to the account on a monthly basis). In contrast, monthly compounding interest only adds interest at the end of the month.
• Impact on earnings: Daily compounding interest will net more interest income in the long run, this will be dependent on the principal, the interest rate, and the annual percentage yield (APY).
• Accessibility of funds: If daily compounding interest is only posted monthly, there is likely not much of a difference in liquidity of interest earned in a monthly interest savings account compared to a daily interest savings account.

When searching for the best monthly interest savings account, consider the following factors:

• Interest rate: Compare the annual percentage yield (APY) offered by different accounts to maximize your earnings.
• Compounding frequency: Opt for accounts that compound interest monthly for faster savings growth.
• Fees and requirements: Be aware of any maintenance fees, minimum balance requirements, or account limitations that may affect your savings goals.
• Financial institution stability: Choose reputable banks or credit unions with a history of financial stability and strong customer service.

Understanding how interest accrues on savings accounts and the impact of compounding frequency is essential for maximizing your savings potential. By opting for accounts that compound interest more frequently allows you to leverage the power of compound interest.

Ready to start watching your savings grow steadily over time? Start exploring the best daily compounding interest savings accounts today and take control of your financial future.