Managing Money:
Building Savings
How Your Money Can Grow
A real benefit of saving money is how your money can grow. Making regular payments to yourself, even in small amounts, can add up over time. The amount your money grows depends on the interest earned and the amount of time you leave it in the account.
Here's an example of your money not growing: if you have $1,000 stashed away under your mattress for one year, it will still be $1,000 at the end of the year. Your mattress is not paying you interest for keeping your money.
Now let's look at interest and the power of compounding. This is how your money can grow. When you compound interest, you earn money on the interest you leave in your account. Interest can be compounded daily, monthly, quarterly or annually. Not all savings accounts are created equal!
Compound Interest Exercise:
$1,000 at 5 percent compounded annually earns $50 of interest at the end of one year. You made more than if you kept it under your mattress!
If you deposit $1,000 in an account that has daily compounding, at the end of the first day you would have $1,000.14. ($1,000 at 5 percent divided by 365 days) The next day, the interest is calculated based on the entire amount of your original deposit of $1,000 PLUS the previously earned interest—$1,000.14 rather than just $1,000.
By the end of one year you would have $1,051.27. The extra $51.27 does not seem like much at this point. However, the table below shows the difference it makes over time.
| 5 Years | 10 Years | |
| No Interest | $1,000 | $1,000 |
| Annual Compounding at 5% | $1,276 | $1,629 |
| Monthly Compounding at 5% | $1,283 | $1,647 |
| Daily Compounding at 5% | $1,284 | $1,649 |
This table uses the same $1,000 to show how your money grows faster the more often interest is compounded and the longer it stays in the account. The $0.14 adds up over time!
The table below shows that even small amounts of savings add up. Look what happens when you save just $1 a day.
| No Interest | 5% Daily Compounding | |
| Year 1 | $365 | $374 |
| Year 5 | $1,825 | $2,073 |
| Year 10 | $3,650 | $4,735 |
| Year 30 | $10,950 | $25,415 |
At the end of year one, you would make an extra $9 compounding interest. The real power of compounding shows at the end of 30 years, you would make an extra $14,465!
The amount of interest your savings will earn depends on the Annual Percentage Yield (APY) — APY is the amount of interest you will earn on a yearly basis expressed as a percentage. The APY includes the effect of compounding. When comparing different accounts, you should compare the APYs of the savings products, not the interest rates. The higher the APY, the more interest you will receive. The interest you earn is considered income and is taxable.
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