What is compounding interest and how can I benefit?
Compound interest is a great concept to understand as it can make a significant impact to your financial wealth over the long term. It can help you when selecting a savings account or when choosing how to invest your money.
The easiest way to explain compounding interest is: earning interest on interest. That is, you not only earn interest on your principal deposit amount, but also on the interest accumulated on your investment.
For example, if you deposit $50,000 in to an account that is paying 3.00% per annum, compounding monthly, after a 12-month period you would have made $1,520.80 in interest. If you were to compare this to a non-compounding or simple-interest earning account, you would have only made $1,500.
At first glance it may not appear like a lot extra, however, the beauty of compounding interest is that your wealth grows accumulatively, without you having to put in any extra effort towards saving. That means over a long period of time, the interest you’re earning can experience exponential growth. It’s important to note, in order to maximise the effect and effort of compounding interest, you need to avoid withdrawing the interest from the account.
What types of accounts offer compounding interest?
Most Australian Deposit taking Institutions (ADIs), will have a range of different account types that offer compounding interest. However, the terms and conditions of how the interest is calculated and paid can be very different – so be sure to do your due-diligence.
Account types that can offer compounding interest options:
- Savings accounts
- Online savers
- Bonds
- Term Deposits
- Superannuation accounts
What to look out for?
When selecting a compounding interest account, there are a number of things to be aware of. This will help you make the right decision based on your long-term saving goals. Some items to research when choosing an account, include:
- How regularly interest will be paid.
- How regularly interest is calculated. Some financial institutions will offer different rates based on whether interest is calculated daily, monthly, quarterly, or annually.
- Are there any honeymoon or introductory interest rates that you need to be aware of?
- Are there any conditions around minimum deposit amounts? Or monthly minimums that you must satisfy to be eligible for the offer?
- Are there any fees and/or charges?
- What are the terms of your agreement, e.g. how long will you invest the money for?
In what cases do you need to be cautious of compounding interest?
The thing with compounding interest is the more often interest is compounded, the more you earn – or in the case of Credit Cards, the more you pay.
That means any outstanding balances on your credit card could be calculated and compounded daily[1], making it harder for you to pay off your debts.
In these scenarios, it’s important that you know the conditions of your agreement and take advantage of any interest-free periods that are offered.
If you’re interested in learning more about compounding interest, or the range of compounding interest accounts offered by Gateway Bank, why not give one of our Member Care Team a call on 1300 302 474 (Monday – Friday, 8am – 6pm, AEST).
[1] Note: Under the Credit Card reforms, from January 2019 there is a ban on back-dated interest charges. A card issuer would therefore be looking at the outstanding balance on the due date and applying interest at that time.
