What is a compound interest account?
With so many types of savings accounts out there, choosing where to put your money can seem like a big decision. One factor that can help you determine which account is right for you is whether it has compounding interest. But you may be wondering, “What is a compound interest account?”
A compound interest account pays interest on the account’s principal balance and any interest it had previously accrued. Because higher principals net higher returns, and higher returns then add to those principals, growth from compounding becomes progressively stronger with time. Let's understand the basics of compound interest, how it’s calculated and why it can be so effective for building wealth.
How a compound interest account works
Compound interest starts slow but accelerates with time. Typically, compound interest accounts apply interest multiple times throughout the year, ranging anywhere from daily to quarterly and beyond. Every time this interest is calculated, it includes the total account balance of the principal and any previously accumulated interest. More money generates more interest, and vice versa.
When choosing accounts, compounding frequency is as important a consideration as interest rates. The more often an account compounds, the more rapidly this interest accumulates and the faster your money grows. Two accounts with the same interest rate but different compounding frequencies will not grow in the same way.
Certificate of deposit (CD) accounts also have compounding interest. They’re specialized deposit accounts that may offer slightly higher interest rates in exchange for “locking in” your funds for specified time periods, called terms. In many cases, the longer the term, the higher the interest rate. CD accounts tend to compound monthly or daily (though this varies from account to account) and may be a valuable tool for building wealth over time.
Simple interest vs. compound interest accounts
While compound interest is calculated based on both the principal balance and previously accrued interest, simple interest accounts pay interest only on the original principal.
For example, a simple interest account with $1,000 dollars and an interest rate of 1% annually earns $10 a year, every year, based on the original deposit.
On the other hand, a compound interest account with the same $1,000 and 1% interest rate will also close out the first year with a balance of $1,010. Next year, however, that interest rate gets applied to the full $1,010 (principal balance and previous interest), to earn $10.10.
When choosing between simple interest and compound interest accounts, no detail is too small. Learning about the different types of savings accounts and what makes them unique can help you decide which one is right for you.
Features to look for in compound interest accounts
Many savings accounts compound, but some compound interest accounts align with your goals and priorities more than others. Be it a CD account, money market account or high-yielding savings account, they all share a few key metrics that may be worth considering when deciding where to park your money.
Higher interest rates are generally desirable because they tend to have larger impacts on the rate your money grows. As you learned, however, compounding frequency (whether the interest is accrued daily, monthly, quarterly, etc.) is equally important. With all else equal, an account with a higher compounding frequency will typically outgain an account that compounds less often.
Meanwhile, the annual percentage yield, or APY, is a calculation that considers interest rates alongside compounding frequency. APY shows the real rate of returns you can expect over a year and may be a useful tool for comparing accounts with different compounding frequencies.
Tools for compound interest calculations
Not everybody loves math. Luckily, Chase’s online calculator tools can do it for you. Whether it’s learning how much interest you could earn or seeing where you stand in achieving your financial goals, Chase’s calculators can help you assess your finances.
Compound interest calculator
The Chase compound interest calculator automatically calculates how much your CD account will be worth upon maturity.
Savings account interest calculator
Using interest rates, deposits and compounding frequencies, the Chase savings account interest calculator tells you how much interest you’ll earn over a set time period.
Savings comparison calculator
Chase’s savings comparison calculator compares potential returns between accounts, helping you assess which accounts may give you more growth over time.
Million-dollar tracker
By entering in your principal, expected returns and your target date, the million-dollar tracker shows you how on-track you are to see your savings become worth a million dollars.
In summary
Answering "What is a compound interest account?" boils down to understanding how compound interest works. A compound interest account pays interest on both your initial investment plus any interest previously accrued. This interest-upon-interest appreciation is the “compounding” factor that grows with time. Simple interest accounts, on the other hand, only pay interest on the original principal. Knowing the difference between the two is an important consideration for anyone looking to start building wealth and financial security.
