Savings accounts are different to transaction/everyday accounts.
Savings accounts are a way of growing the amount of money you put in. Depending on how much money you put in, the bank will add more money based on compound interest.
Usually when you open an everyday account you can also open a savings account with the same bank and link them together. You can then transfer money between accounts and track your savings progress using the banking app or website.
Understanding the words banks use
Before understanding what compound interest is, you need to know some other words.
- Principal: this is a word you’ll hear a lot when it comes to loans and credit. It means the ‘original’ or ‘first’ sum. When we’re talking about saving money, it means the amount you put in the account.
- Interest: interest is the money the bank adds as an incentive to choose their bank. They work out how much money to add to your account based on how much principal is in there.
- Interest rate: the way the bank decides how much interest to add, is based on an interest rate. It’s presented as a percentage, like 1.8% per year.
Compound interest grows your savings
Let’s pretend the interest rate on a savings account is 2% per year. For every dollar you put in the account, you’ll get 2% added at the end of the year, which equals $0.02. A principal amount of $100 that you put in your account will have $2 worth of interest added by the bank.
That $2 might not seem much but the good news is, compound interest is interest you earn on top of both the original $100 and the $2 of interest. The next lot of interest is calculated on $102 and so on. If you make even very small deposits, that will add up over time.
This is how your money grows when it’s in a savings account. You earn interest on both the money you’ve saved and the interest you’ve earned while it’s been in the account.
The Australian Government website Moneysmart has a calculator to help you work out compound interest:
Bonus interest rates
There are lots of banks and they’re all competing to get you to open an account with them. One of the incentives they use is bonus interest rates.
A bonus interest rate is usually a higher interest rate that you can normally have, but only if you do certain things. That might mean depositing a certain amount of money in the account every month, increasing the balance every month, or making no withdrawals during the month.
The Australian Government website Moneysmart has useful information to help you compare different savings accounts: