The power of compound interest

Most banks pay interest on the amount you first deposited and on the interest your deposit has earned over time. It’s called “compounding.”

AliciaOK, let’s say you put your savings in an interest earning account, like a bank savings account. The amount of interest you’ll earn depends on three factors:

The first factor is the interest rate. The higher the interest rate, the more your money grows.

The second factor is how long you keep the money deposited in your account. Time is one of your most important tools for saving and investing. The more time your money has to grow, the better.

And the third factor is how the bank pays the interest. Almost all banks compound interest. Compounding means a financial institution pays you interest not only on the amount you originally deposited, but also on the interest your deposit has earned over time.

CassieDepending on the account, the interest may be compounded daily, monthly, or quarterly. Each time, you’re paid interest on the new, total amount you have in your account. So the more frequently your money is compounded, the more interest you’ll earn.

AliciaWhen you’re out shopping for a savings account, here’s a quick way to determine which account will pay you the most. Just compare the annual percentage yield, or APY, of the accounts. The higher the APY percentage, the more interest you’ll receive.

Review these key terms

Simple interest
If an account pays what’s called simple interest, that means you only earn interest on the principal, that is, the amount of money you originally deposited.

Compound interest
If account pays compound interest, that means the financial institution will pay you interest not only on your original deposit but also on the interest your deposit has earned over time. With compound interest, your money grows more — and a lot faster!

Annual Percentage Yield (APY)
The rate of return on an investment, such as a deposit in an interest-bearing savings account, for a one year period.

Is the interest I earn taxable?
Yes. The interest you earn in your bank accounts is considered income, so it is taxable. The bank will send you a form at the end of the year that shows the total amount of interest you earned.

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