What is the difference between compound and annual interest?

Differences between compound and annual interest

The subject of compound versus annual interest tends to confuse many consumers – with good reason. The concepts and procedures, however, are actually quite simple and straightforward. Instead of dealing with banking philosophy and theory, a simple savings calculator should clarify any confusing elements.

Example #1:
You deposit $10,000 in an account that pays you 5% interest annually (interest is posted once per year). If you deposit these funds on January 1^st, at the end of the first year, you will earn $500.00. Simple.

Example #2:
You deposit $10,000 at 5%, with interest posted (and compounded) quarterly. With compounding, you will earn $509.46 the first year of this account. This results in an APY (Annual Percentage Yield) of around 5.1%.

Compound interest, over time, will earn you a great deal more money on a deposit account than annual interest. An account that posts interest daily, weekly, or monthly will further increase the positive effects of compound interest. Understand this potentially important difference when you evaluate deposit accounts to determine which are the best choices for you.

Over long periods of time, as with retirement accounts or other long-term savings options, the effects of compounding can be huge. Even an account started with one penny with interest compounded daily will be worth millions of dollars over time.

When comparing savings rates, always take into consideration whether or not compound interest factors into the equation.

Recommended resource: Compound savings calculator