How Does Interest Rates Work on Savings Accounts?

Let’s pretend you had N1,000 in the bank, and it was earning 1% interest. Fat chance, eh? In these days of rock-bottom interest rates on savings accounts, you’re doing pretty well if you get a whole 1% interest. But this story is all about compound interest and how it works, and 1% is a good round number to use as an illustration of how it works.

Interest on Interest

Then N1,000 at 1% interest per year would be, at the end of a year, N1,010. But that is, accurately, simple interest, paid only on the principal. Money earns compound interest when interest earned is added to the original deposit each time it’s calculated. So in the instance of a savings account, the interest is compounded, either daily, monthly or quarterly, and you earn interest upon the interest. The more often the interest is added to your balance, the faster your savings will grow.

Within 10 years, your N1,000 would grow up to N1,105.17 with compound interest. Your 1% interest rate, compounded daily for 10 years, has added more than 10% to the value of your investment.

Well, it may be depressing. But now deliberate on what would happen if you were able to save up to N100 a month, and add it to the original deposit of N1,000. After one year, you would earn N16.57 in interest, for a balance of N2,216.57. After 10 years, still adding just N100 a month, you would earn N730.93, for a total of N13,730.93.
Still not enough fortune, but it is a reasonable rainy day fund. And that is the core purpose of a savings account.

Start Early, Save Often

Still, Franklin’s experiment demonstrated that compound interest can build wealth over time, even when interest rates are at rock bottom. If you want to get started, you can find out which banks currently offer the best interest rates. Make sure that interest on the account is compounded daily, and that no monthly fees are charged.