Compound Interest Helped Me Double My Savings In One Year

view original post

Almost one year ago, I moved $1,000 to a high-yield savings account and set up regular automated transfers from my checking account. My goal was to double my savings before the end of 2024 without having to budget or make major sacrifices. 

Today, I’m happy to report I’ve met my goal. The magic of compound interest helped me… a lot. 

Compound interest can be both good and bad. When you’re saving money with a savings account, compound interest is on your side, helping to accelerate the growth of your dollars. However, if you’re borrowing money or carrying debt, like with a high-interest credit card, compound interest is working against you.

When we understand compound interest, we can make better decisions about how to save and spend money. Although the Federal Reserve is starting to cut interest rates, it’s still a great time for savers to take advantage of automating deposits into a high-yield savings account. That’s how I doubled my savings in just one year without lifting a finger. 

What is compound interest?

First, let’s get our definitions straight. Albert Einstein famously referred to compound interest as “the eighth wonder of the world.” Anyone who understands compound interest, earns it. Anyone who doesn’t understand compound interest, pays it. 

When you put money into an account that earns compound interest, you aren’t just earning interest on your initial deposit amount (known as the principal). Your interest also earns interest, therefore growing your account balance. In contrast, simple interest applies to the principal only.

In other words, compound interest is a powerful and simple way to increase the value of your savings. But you’ll need the right savings account, money market account or investment tool, like a certificate of deposit. 

Read more: How Savings Interest Works

Why go with a high-yield savings account?

Stashing money in a high-yield savings account is a low-risk way to take advantage of compound interest and maximize the growth potential of your returns. 

Look for the percentage attached to the APY, or the annual percentage yield. The top high-yield savings accounts currently earn APYs as high as 5.25%, more than 10 times the national average of savings account rates, which is 0.45%. 

Let’s say you deposit $1,000 in a high-yield account that earns a 5% annual percentage yield and compounds interest daily: You’d end up with a balance of about $1,051 in one year without making any additional contributions. Assuming that the same 5% APY is applied to your new balance, you’d end up with $1,105 after the second year. And so on. 

The higher the balance in an account, the more you’ll earn in interest. Say you deposit $10,000 into that same high-yield account with a 5% APY compounding daily. You’ll have roughly $10,513 after the end of one year. That breaks down to almost $43 extra cash each month toward your savings goal.

The start of my savings journey 

Last December, I opened a high-yield savings account with Ally that, at the time, had an APY of 4.35%. Today, Ally’s HYSA earns a 4.00% APY. Compare that with my previous savings account at my local credit union, which earned a paltry 0.01% APY.

As a general rule, online-only banks consistently offer better APYs on savings accounts because they have fewer overhead costs than banks with physical branches.

Here’s what the interest looks like for each account after one year based solely on an initial deposit of $1,000:

	Traditional savings account	Ally high-yield savings account
APY	0.01%	4.00%
Initial deposit	$1,000	$1,000
Compound frequency	Daily	Daily
Balance after 1 year	$1,000.10	$1,040.81
Interest earned	$0.10	$40.81

That’s an extra $40 just for parking savings in a higher-yield account. Keep in mind, however, that savings accounts earn a variable interest rate, meaning the APY can change anytime. Variable interest rates can be unpredictable, but the interest rates for top-yielding savings accounts are expected to stay high for a while.

How you can double your savings in one year

Small strides are still strides in the right direction. You don’t need to set aside $100,000 to make noticeable gains with your savings. Here’s what to do. 

🏦 Deposit $1,000 (or any amount) into a high-yield savings account

Start by depositing $1,000 or a suitable amount in a high-yield savings account that earns 4% to 5% APY. Ally’s high-yield savings account currently earns 4.00% APY, but you can find savings accounts with rates as high as 5.25% APY. Make sure your initial deposit is a comfortable figure that you can put aside for at least a year without needing to withdraw it for daily expenses. 

💸 Set up automatic transfers of $25 per week

Set up automatic recurring transfers to move money into your savings account on a weekly, monthly or quarterly schedule that works for your finances. Automating your contributions is a way to “set it and forget it.” You won’t ever have to manually deposit funds into your account, and your savings will still grow consistently. 

In my case, I set up a recurring automatic transfer of $100 from my checking account into my Ally savings account every month, which is $25 a week. That was a reasonable amount based on my income, debt and expenses, but the exact amount you set aside will depend on your budget. 

👀 Watch your balance double

Since interest rates are variable and will likely decrease now that the Fed has issued two rate cuts, keep an eye on your contributions and adjust your projections when the time comes. Luckily, savings rates won’t plummet overnight. 

In my case, over the last year, the APY on my Ally account dropped from 4.35% to 4.00%. Since the change in APY was minimal, I didn’t need to change my savings approach to meet my goal.

Initial deposit	$1,000
APY	4.00%
Automated contribution amount	$100
Contribution frequency	Monthly
Compound interest frequency	Daily
Balance after 1 year	$2,265
Interest earned	$65

After one year, my $1,000 turned into around $2,265. Not too shabby.

What’s the difference between interest compounding daily vs. monthly?

How frequently your interest compounds determines how quickly your principal balance grows. Banks and credit unions can compound interest annually, monthly or daily. Most high-yield savings accounts compound interest daily and pay it out monthly.

While interest compounded daily can get you greater returns than interest compounded monthly or annually, the difference isn’t substantial. For your savings to grow, the more important factors are the APY and the length of time you save.

Let’s look at how interest compounded daily versus monthly can affect your savings:

	Daily compounding	Monthly compounding
APY	5%	5%
Initial deposit	$1,000	$1,000
Contribution amount	$100	$100
Contribution frequency	Monthly	Monthly
Balance after 1 year	$2,281.69	$2,279.05
Balance after 2 years	$3,629.08	$3,623.53
Balance after 5 years	$8,100.09	$8,083.97

Is there a downside to earning compound interest? 

When compound interest applies to your savings earnings, you’ll be able to get more value over time, though you’ll always have to factor in APY and the length of time you invest. If the APY on your account is far below 1%, compound interest will only amount to a few extra pennies. 

Keep in mind that any interest you earn from a savings account is considered taxable income by the IRS. When tax season rolls around, you’ll have to include the interest you earned for the filing year on your federal tax return. 

If you want to boost your wealth significantly, this savings strategy might be too “G-rated” for you. Investing your money in the stock market could get you greater returns in the long term, but you’ll have to evaluate your risk tolerance. 

The bottom line

I’m pretty vocal about my journey of paying off student loan debt and learning new ways to save while juggling debt. It’s all about finding the right balance for your financial situation. 

Though high interest rates mean it’s not a great time to be a borrower, it’s still a good time to be a saver. Take advantage of the power of compound interest while APYs on savings accounts are high. The sooner you do, the more interest you’ll earn.

Einstein was right.

–>