Those who want their savings to grow need to understand how the interest rate works. Perhaps it could even be said that having a basic notion like this is not enough, unless one knows how to calculate interest rate.
Think that only then will you be able to better plan your future because would allow you to compare the performance of one account or another, decide if you should transfer your savings to another bank or if, on the contrary, your profits could not be better than what you are obtaining.
Wondering how to calculate the interest rate on your savings? It is very easy and more with the techniques that we will give you in this post.
Tip: In this article, you will learn how to calculate simple interest, fixed interest on certificates of deposit, compound interest, and the return on ongoing investments, such as monthly deposits, for example. The methods could be summed up in three: formulas, free online calculators, and Google Docs spreadsheets.
Do you not want to read the entire article because you prefer to take advantage of this time to calculate your interest rate? Do not worry! we leave you one interest spreadsheet so you can do it. To use it, it is important that download the template or save a copy to your own computer or cloud storage, as you prefer!
Keep reading: What is the 50/30/20 rule to save successfully?
- 1 How to calculate the interest rate on your savings?
- 1.1 Before calculating the interest rate on your savings, get organized!
- 1.2 How to calculate simple interest?
- 1.3 How to calculate compound interest?
- 1.4 How to calculate the interest rate on your savings with a spreadsheet?
- 1.5 How to calculate the interest rate on your savings if you make deposits continuously?
How to calculate the interest rate on your savings?
Note: When you make a deposit into your savings account or apply for a certificate of deposit (CD) that offers any bank or credit union, you are lending money to the bank. What does this mean? That the bank will take your money and invest it to multiply it or that it will lend it to other people through the granting of personal loans, car loans, revolving credits, lines of credit, mortgage loans, among others.
Warning: This does not mean that if you need your money right away it will not be available. The bank or cooperative will always make sure to safeguard your capital.
Before calculating the interest rate on your savings, get organized!
For calculate the APY of your savings (or any of the interest rates to which your savings accounts and instruments are subject) gather the following information:
- The amount of your deposit, which will be your balance or the capital invested or deposited. We will identify this variable with the letter “P”.
- The frequency of application of interest, which can be monthly, yearly or daily. We will call this frequency “N”.
- The interest rate applied, which will be introduced to the formula with the letter “R”. Remember that we will not use a percentage, but we will convert this number to a decimal.
- Interest application time, which will be the term in which your capital will be generating interest. We will use the letter “T” to put this time term in years.
How to calculate simple interest?
Let’s start by calculating simple interest. Suppose you deposit $100 in a savings account that earns interest annually at 5%. How much will you have in a year if you leave the principal and interest intact?
In order to determine the cost effectiveness, we will use one of the most basic formulas, which is that of simple interest:
Interest = P x R x T
So, let’s plug the example data into the formula:
Interest = $100 x 0.05 interest x 1 year = $5
This formula will work for you if your interest rate is calculated as an annual percentage yield, that is, an APY., and provided that the calculation is made for a single year. Most banks advertise the APY with which they work, as this factor is usually higher than the regular interest rate and, in addition, it is a quick and easy way to show the client what capitalization their money will have.
How to calculate compound interest?
When we talk about capitalization, we refer to the application of what is known as interest on interest, that is, your capital generates an amount of interest that, at the end of a term, is added to the principal capital. For the second year, for example, that capital plus interest will generate even more interest. Therefore, you will generate more money.
Let’s see it in an example. Suppose you earned $5 in the first year. For your second year, your account amount will no longer be $100, but $105. By applying the 5% rate, you will earn $5.20 in interest. Consequently, your ending account balance at the end of the second year will now be $110.20. Notice that, in the first year, your savings generated only $5, while in the second – when interest was applied on interest – it reached $5.20.
Now, to calculate the compound interest of a savings account, you must take two elements into account:
- The frequency of the periodic payment. Many savings accounts pay interest more than once a year. For example, your bank might add the interest to the principal in your account at the end of each month.
- How your bank balance grows. Keep in mind that any monthly interest payment will alter the calculation of subsequent interest. Why? Because your balance will grow month by month.
Let’s see how the compound interest of a savings account is calculated in a formula. To do so, we will take the same data from the previous example. We will only change this information: the bank pays the interest monthly and not annually. Now, the formula that we present below will help you calculate this interest over a one-year term. Let’s go to see her!
Interest = P (1 + R / N)^ NT
Note: The symbol “^” means “raised to the power”, that is, it is an exponential equation. Find this number on the scientific calculator on your smartphone or on the computer and you should be able to complete the operation without problems.
So, taking the data from the example, let’s see how much you would earn with compound interest:
Interest = $100 x (1 + 0.05 interest / 12 months)^(12 months x 1 year)
Interest = $100 x (1.004167)^ (12)
Interest = $100 x 1,051
Interest = $105.1166 (or $105.12 if your bank rounds the figure)
Notice that the result of the equation shows that monthly compounding increases your annual return.. While with the simple interest formula you only earned $5, with the compound interest formula you would earn $5.12. Although the interest rate in both examples is the same – 5% – the APY in the compound interest example is 5.12% and not 5%.
The more frequent the interest compounding that your bank offers you, the higher the APY you will earn in a year. An additional 12 cents may not seem like such a big win to you, but keep in mind that this number will change over time. Furthermore, you could also be influenced if the initial deposit is not $100 but $10,000. In this case, you would earn $512.
How to calculate the interest rate on your savings with a spreadsheet?
Spreadsheets could be perfect for you if you want to automate the process and save time.. Think that, in addition, if you use a spreadsheet you could modify the data whenever you want and obtain a result almost immediately. To calculate your earnings, you’ll need to use the “future value” formula that you’ll find in the menu of any calculation program, such as Microsoft Excel or Google Sheets. This formula is called “FV”.
At the beginning of the article, we leave you a spreadsheet already programmed with a rate of 5%. Download the template and modify the values depending on your case. Do you prefer to make your own spreadsheet from scratch? No problem! Enter the following information in your cell to calculate simple interest:
Note that each factor is separated by a comma:
- The interest rate, which is 5%, is entered in decimals. (To get your percentage in decimals, divide it by 100)
- The number of periods, which is 1 because the interest is paid once a year according to the example.
- The periodic payment, which in the example is zero because you are not expected to make deposits in the future.
- current value, which is $100. This value corresponds to the initial capital of your account.
tip: If you want to create a much more advanced spreadsheet, enter the rate, time, and principal balance in separate cells. Then select these cells when writing your formula. Thus, you can easily adapt it to different amounts in the future.
Note: If you want to adapt this formula to compound interest, you will have to adjust some values. First, to change the annual rate to a monthly rate, divide the 5% rate by 12 months (0.05/12). This will give you 0.004167. Then increase the number of periods to 12, since the interest is reflected on a monthly basis. To calculate monthly compounding over multiple years, use the number of months equal to years. For example, for four years it would be 48 months.
How to calculate the interest rate on your savings if you make deposits continuously?
The examples above assume that you make a single deposit, which is the initial one. But this is not usual among savers. In fact, the common thing is to make some small deposits in the account regularly. With a small adjustment in the formulas, you will be able to account for those additional deposits as well. Let’s see how!
Note: This formula will help you calculate the profitability of the deposits you make at the end of each month instead of a single deposit.
We will take the data from the previous examples to explain how the formula is applied. That is, the data will be the same, except for the initial deposit. In this case, let’s say you start the year with $0 and make multiple deposits of $100 a month for five years:
Take into account that we are going to use a monthly interest rate calculated with 5% per year, that is, you will have to divide 0.05 by 12 months. To calculate the five-year return, multiply the 12 months – which is one year – by 5 (60 months).
To do this without a spreadsheet, we’ll use the future value formula. In this formula “PMT” will be the amount of the monthly payments, “R” the monthly interest rate and “N” the number of months that the deposited money will last.
Future value = PMT x (((1+R)^ N) – 1) / R)
Future value = 100 x (((1 + 0.004167) ^ 60) – 1) / 0.004167)
= 100 x (1.283 -1) / 0.004167
= 100 x 68.0067
Future value = 6,800.67
Note: The result obtained could vary if the bank uses the rounding method, but not by much.