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There's a reason why compound interest is considered one of the seven wonders of the world. Because it allows you to earn interest on your interest over and over again, so your money continues to grow even if you're not adding to it.
How does compound interest work?
To illustrate how compound interest works, let's look at the following fictional example.
Let's say you invested $1000 with an interest rate of 10% p.a. compounded for 5 years. The initial investment of $1000 will earn $100 in the first year, giving you a total of $1100. The following year, you'll still earn the same rate of 10% p.a. but this time it'll be applied to $1100, not $1000. This will make your balance $1210 after the second year, even though you haven't added any extra money into the account yourself. This amount will then be the base for compounding for the third year, and so on.
- Maximum rate: 3% p.a.
- Standard variable rate: 0.2% p.a.
- Monthly fees: $0
Compound interest savings accounts
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
Use our calculator to see how you can benefit from compound interestBack to top
How can compound interest work for you?
Compound interest is a great way to make your money work harder for you, and can help you reach your savings goals sooner. Compound interest can turn a small amount of money today into a large amount of money over the space of 10, 20 or 30 years. The best part is you don't need to be an investor to get it - anyone can benefit from compound interest.
To get the most benefit out of compound interest, deposit as much as you can into your account and restrict the number of withdrawals you make. The more money that is in your account at the end of the month, the more interest you will earn, and the more interest you earn means you will earn even more interest the following month. However even if you can't deposit any extra money into your account, your balance will continue to grow as your interest compounds each month.
How do the banks calculate compound interest?
Interest is typically calculated on a daily basis on the daily closing balance. Here's the savings account equation:
Daily closing balance x interest rate (as a percentage) / 365
Interest begins to accumulate on the day the opening deposit is made in your savings account. It's then usually credited into your account on the last day of each month. If you choose to close your account, your accrued interest will be deposited on the day it's closed.
Any interest awarded to your savings account is usually available for use on the same day it's been credited. The daily closing balance of your savings account tends to include all cleared and uncleared transactions. This may be because electronic transfers to your linked bank account usually occur on a business day.
How do you find the monthly interest rate?
The monthly variable interest rate will be clearly displayed on the provider's website under the product description for the particular account you’re looking at. Instead of going to each bank's website, you can take a look at the latest high interest savings account interest rates in our guide. It is important to remember that the interest rate is variable, meaning it will change from time to time.
What are the pros and cons of compound interest?
While it may seem like choosing an account with compound interest should be your only option for maximum benefit, there are other things to take into consideration. Think about the pros and cons of compound interest before you dismiss those accounts which don’t offer it:
- Account accessibility. The majority of Australian savings accounts that provide compound interest do so without any set terms. These on call accounts allow you to make withdrawals and additional deposits whenever you need to.
- Lower balance requirements. Many accounts that offer compound interest do so with a low minimum balance requirement.
- Bonus rates. You can find savings accounts with compound interest that do give you an incentive of bonus interest for not making any withdrawals in a month. This encourages you to save, yet still gives you access to your money easily in case of an emergency.
- Increased interest income. With compound interest, your earnings are being increased exponentially, as each month the interest is being calculated on a slightly higher balance.
- Lower rates. The drawback to earning compound interest is that the annual rates are sometimes not as high as accounts like term deposits where interest is not compounded monthly.
- Accessibility. For some Australians, having open access to your savings is a discouragement, as you can easily dip into it for daily needs, causing you to lose a portion of your interest earnings.
Frequently asked questions
How can I tell if a savings account pays compound interest?
You will want to first look at when interest is paid, and then where. Interest that is paid monthly into the savings account will be compounded. However, on some term deposits for example, you can choose to have monthly interest payments, but these are paid into your linked account, not added to your balance.
If my savings account requires a minimum monthly deposit, will my earned interest count towards that?
In most instances no, the minimum monthly deposit requirement must be met with other money.
Will my interest earnings be taxed?
Yes, banks are required to withhold tax on your interest earnings. The amount depends on your personal circumstance. To avoid having tax withheld at the highest marginal rate, you should always include your tax file number (TFN) and exemption codes on your application.
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