Earning interest on your savings is crucial if you don’t want your money to lose purchasing power due to inflation.

Knowing how to calculate interest on savings accounts can help you use them to their full advantage. You’ll be able to predict how much you can earn every month on your savings account balances. We’ll go through the calculation and some ways to earn a higher interest rate on savings.

Read more: How to protect your savings against inflation

How to calculate interest on savings accounts

There are some important terms to know related to calculating interest on a savings account. A few key terms include:

• Interest rate: This is the percentage of your savings that the bank pays you in interest over a specific period (usually one year).

• Annual percentage yield (APY): The annual percentage yield is the amount of interest customers earn over one year when compounding frequency is factored in.

• Compound frequency: This refers to how often the financial institution compounds interest on an account. It may be compounded yearly, semi-annually, quarterly, monthly, weekly, or daily. The more often interest is compounded, the faster the balance will increase. Many savings accounts offer daily compounding interest.

• Principal: This is the starting balance you contribute to a savings account before interest accrues. For instance, if you open your account by depositing $1,000, this amount is the principal.

How to calculate simple interest on a savings account

Calculating interest on a savings account involves a simple formula that includes the account balance, the interest rate, and how long the money is deposited. The formula for calculating simple interest is:

A = P * R * T

• A = Ending account balance

• P = Principal or starting balance

• R = Interest rate (usually expressed as an annual rate)

• T = The number of years the money is in the account

For instance, suppose you have $5,000 in a savings account with a 3.5% annual interest rate. To find out how much your principal balance would earn in one year, you’d use the following formula:

A = 5,000 * 0.035 * 1

This gives us an annual interest amount of $175. To break down interest earnings by month, you can divide the ending amount by 12, which results in a monthly interest payment of $14.58.

Again, this formula is a simple interest calculation. However, most savings accounts have compound interest. That means the interest you earn each month is added to the account balance, and that interest also begins earning interest, creating a snowball effect.

How to calculate compound interest on a savings account

The formula for compound interest on a savings account is more complex than the simple interest formula, but it’s still relatively straightforward:

A = P(1 + R/N)ᴺᵀ

• A = Ending account balance

• P = Principal or starting balance

• R = Interest rate (APY)

• N = The number of times the account compounds per year

• T = Number of years

To see compound interest in action, let’s take a quick look at an example calculation.

Using the same numbers from earlier, suppose you deposit $5,000 in a savings account that earns 3.5% APY. You leave the money in the account for one year, and interest compounds daily.

In this example, the compound interest calculation is:

A = 5,000(1 + 0.035/365)¹ * ³⁶⁵

This gives you an ending balance of $5,178.09, including $178.09 in interest. This is slightly more interest than you would receive with simple or monthly interest calculations, as shown below:

As you can see, compound interest results in more earnings than simple interest. And the difference becomes more significant as your account balance grows.

Tips for getting a higher savings account rate

There are several ways you can get a higher savings account rate. Here are a few tips that can help you earn more interest:

1. Switch to a high-yield savings account: These accounts generally pay much higher rates than traditional savings accounts, allowing you to earn more interest on your deposits. You can see our picks for the best high-yield savings accounts here.

2. Compare rates: Many high-yield savings accounts are available, and some pay higher rates than others. While earning a fraction of a percentage won’t make a huge difference in most cases, it can sometimes be worth considering. And some high-yield savings accounts currently offer 5% APY or more.

3. Maintain a high account balance: Some savings accounts have tiered rate structures, where higher account balances earn a higher rate. If your account has tiered rates, keep more money in your account to increase your interest rate.

4. Look for interest cutoffs: Some savings accounts only earn interest up to a certain balance. Try to avoid keeping money in these accounts past the upper threshold for interest earnings.

5. Monitor interest rates: Interest rates tend to change frequently. While most financial institutions adjust their rates at roughly the same time and in the same direction, your interest rate could become less competitive over time. Keep an eye on rates at different institutions to ensure you are still earning a good APY.

6. Consider a CD: Certificates of deposit (CDs) allow you to lock in yields for long periods — typically, one to five years. This is useful in periods when interest rates are falling. However, you usually must keep your money in the account for the entire period to avoid penalties.