The Power of monthly contributions and compounding

Most banks calculate accrued interest daily and credit monthly.  This means that banks take the daily balances and accrue interest on each day. The total interest calculated for the days are totaled to get your monthly interest that is deposited to your account.  This method is typically used because your balance is different each day.  If interest were to be calculated on the balance at the end of each month, the calculation wouldn’t be accurate because the balance at the end of the month is not representative of the balance in the account for the entire month.  You may have deposits and withdraws during the month, causing fluctuations in the balance throughout the month.

For simplicity, we illustrate the below table with monthly compounding at .75% annual percentage yield (APY).  Interest bearing accounts are usually quoted in APY, which is slighter higher than the annual percentage rate (APR), because APY takes into account the compounding of interest.  The calculated interest is added to the balance on which interest is calculated. Basically, you are earning interest on the interest.

As you can see below, an investment of $100 for 18 years will not amount to much.  But, if you make monthly contributions of $100 per month for 18 years, you will have a nice balance.

Year One-Time Contribution $100 monthly Contributions
1 $100.00 $1,305.64
2 $101.51 $2,520.35
3 $102.27 $3,744.20
4 $103.04 $4,977.27
5 $103.82 $6,219.61
6 $104.60 $7,471.31
7 $105.39 $8,732.42
8 $106.18 $10,003.03
9 $106.98 $11,283.19
10 $107.79 $12,573.00
11 $108.60 $13,872.50
12 $109.41 $15,181.79
13 $110.24 $16,500.93
14 $111.07 $17,830.00
15 $111.90 $19,169.08
16 $112.75 $20,518.23
17 $113.59 $21,877.53
18 $114.45 $23,247.06
18 years of savings at .75 APY, assumes monthly compounding.

Most companies offer direct deposit options in which your specified amount would be deposited to your designated bank account(s) each paycheck.  If your employer offers direct deposit options, you should take advantage of this, even if you are only able to contribute a little each paycheck.  With this feature, you can forget about that money, and you will be pleasantly surprised to see how much your balance becomes in a few months and in a few years!

 

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