When it comes to growing wealth, one of the most effective tools that can be used is compound interest. But what exactly is compound interest, and how does it work? Compound interest accounts allow you to essentially “snowball” interest and earn money on interest received. Depending on the account, this means that each time your interest compounds, it is based off the current value rather than the initial principal deposited amount.
What is Compound Interest?
Expanding on this, since compound interest is interest earned on any interest that has already been gained, there’s a multiplying effect that occurs over time. This means that as your account balance grows, the end amount can grow even if the interest stays the same – but as witnessed with rising interest rates, the compounding effect is even greater. Over time, this can lead to a significant increase in your savings. Examples of this are demonstrated with the recent growth of interest rates in Amerant Certificate of Deposit and Relationship Money Market accounts. These accounts started the year on average with lower rates of interest than the 5% and 4% being paid now. Naturally, there are different compound frequencies for each account, and the more frequently interest is compounded, the higher the overall return on investment will be over time. There are 2 main types of interest – Simple Interest and Compound Interest.
Simple Interest Accounts vs Compound Interest Accounts
The main difference between simple interest and compound interest lies in the way they are calculated. Simple interest is calculated as a percentage of the principal amount over a fixed period of time. For example, if you invest $1,000 at a simple interest rate of 5% for one year, you will earn $50 in interest. This type of interest is commonly earned in Certificate of Deposit accounts – especially with the one-time nature of the deposit that’s based on fixed period of time. CDs can earn compound interest if applied annually specially for terms longer than a year.
On the other hand, compound interest not only calculates interest on the principal amount, but also on the accumulated interest over time. This means that as the interest compounds, it generates more interest, resulting in a larger return over time. So if you invest the same $1,000 at a compound interest rate of 5% for one year, you would earn $50 in interest in the first year, but in the second year, you would earn interest on the $1,050 total (principal + interest earned in the first year), resulting in a higher return over time. Overall, compound interest has the potential to generate greater returns than simple interest. Amerant Bank offers multiple types of accounts that allow you maximize your interest earnings over time.
What are the different types of compound interest accounts?
Compound interest accounts come in different types, each with unique features that cater to different investment needs. Here are some common types of compound interest accounts:
This type of account is ideal for people who want to save money for the short-term. Savings accounts (of which Amerant has several types) typically offer a low interest rate, but they provide easy access to your money and are generally FDIC-insured. Some savings accounts offer tiered interest rates that increase as your balance grows.
Like savings accounts, money market accounts also offer a low interest rate, but they require a higher minimum balance. There are exceptions to the low interest rates with promotional money market accounts, like Amerant’s Relationship Money Market account. In exchange for the higher balance requirement, you typically get a higher interest rate than a savings account.
CDs are a type of time deposit that offer a fixed interest rate for a set period of time. They generally offer higher interest rates than savings accounts and money market accounts, but you can’t access your money without penalty until the CD matures. The interest compounds if reinvested at maturity or kept in the account longer than a year on an annually compounded interest rate CD account.
High-yield savings accounts offer a higher interest rate than traditional savings accounts. They typically require a higher minimum balance and may have restrictions on how many withdrawals you can make in a month.
Retirement accounts such as IRAs and 401(k)s also offer compound interest. These accounts offer tax advantages and are designed to help people save for retirement.
Variables to Consider When Selecting a Compound Interest Account
When selecting a compound interest account, there are several variables that you should keep in mind. One of the most important factors to consider is the interest rate, which can vary greatly from one account to another. Another key variable is the annual percentage yield (APY), which takes into account both the interest rate and the frequency of compounding to provide a more accurate measure of the account’s overall return on investment. You should also consider the frequency with which interest is compounded, as this can have a significant impact on the overall return on your investment. Additionally, you should be aware of any fees or penalties that may be associated with the account, such as early withdrawal fees or minimum balance requirements. Finally, it’s important to consider your own financial goals and needs when selecting a compound interest account, as different types of accounts may be better suited to different types of investors. By carefully considering these variables and doing your research, you can find the compound interest account that best meets your needs and helps you achieve your financial goals.
All in all, compound interest is a powerful tool that can help you grow your wealth over time. By earning interest on both your principal and your accumulated interest, you can achieve impressive returns on your investments. However, it’s important to understand the variables that can impact your compound interest earnings, such as the interest rate, frequency of compounding, and any fees or penalties associated with the account. With careful consideration and research, you can select the right compound interest account to help you achieve your financial goals and build a brighter financial future.
Get in touch with an Amerant Bank representative today to learn all about interest accounts and the advantages.