How to Understand Interest That Is "Accrued Daily and Compounded Monthly"

Interest Rates Fluctuate

Learn how to calculate the interest you earn or the interest you owe based on the "calculated daily, compounded monthly" system, used by many banks.

Things You'll Need

• Information about your savings account, money market account, CD, loans, or other interest-making accounts
• A calculator

Instructions

1. 

   While the "APY" idea was supposed the make this interest rate thing easier, it seems as if the opposite has actually occurred. First, figure out what your daily interest rate is. For example, if your APR is 3.0 %, divide that by 365 to find your daily interest rate. .03 / 365 = 0.0000822%. This is the rate that is used to daily calculate your interest. For example, if you have $4,000 in your account/CD/whatever, on Day 1, you will make about $0.328 (because 0.0000822 * 4000 = $0.328). This money is set aside each day during the month into a virtual (make-believe) account.

2. 

   At the end of the month, all of the interest that was earned each day the previous month, is added into the account, thus, combining it with the principal (original) amount. Using our example before, and assuming that you don't deposit or withdraw money during the month (as in a Certificate of Deposit, for example), you would earn $0.0328 per day which is about 31 * $0.0328 = $10.19 per month. So, your new total in the account would be the original + interest = $4000 + $10.19 = $4010.19.

3. 

   During the next month, you earn interest (same rate as before) again but the difference is that now the interest is calculated on your new balance. So, you will earn 0.0000822% of $4010.19 which is about $0.33 per day. a little more than the previous month. At the end of the new month, this $0.33 * 31 = $10.23 is added into your account; now, your new balance is 4020.42.

4. 

   The magic of compound interest is that, even though your rate isn't changing (although it may fluctuate as well), you earn interest on your interest, as well as your principal investment. The secret to building wealth with compound interest is to set aside a small amount into your savings every month and to start early and be consistent. Compound interest only works in the long run - it is not a quick fix.

Tips & Warnings

• Try to find a CD/checking/savings/etc account with a high interest rate (at least as high as you can get). For example, I had my savings in my bank and the rate was like 0.000013% or something like that. I switched only my savings over to an account with another bank online that gives 3% on savings accounts and all other aspects of the accounts are equal. If you don't do this, you are giving away free money.

• Saving money in a savings account or CD will probably not pay enough interest to outgrow inflation. In other words, even though your are "earning money," the money will be less valuable overall down the road. For example, if your $5000 grows at 3% APY and inflation grows at 5%, in 20 years, you would have something like $9030, but it would only be worth about $4900 (based on what you can get for it).

Resources

• Find out more about compound interest