Understanding Savings

savings accountsHave you ever really thought about how savings works or how much savings you will need in the future? If not, now is the perfect time to start planning ahead and making your money work harder for you. By continuously putting some money aside in a high interest savings account now, you will have a sizable nest egg in the future.

Most banks and credit unions offer some type of interest on their savings account. How much interest and how much you can earn depends on a couple of different factors. Understanding these different factors and how they affect your money will help you select the right account to increase your earnings.

The main factors that may determine the rate you receive include some of the following:

- The cash rate which is set by the RBA as this will determine what the banks get and may or may not pass on to you.
- The size of your deposit
- The length of time of your deposit

Beyond the above factors, the biggest component to understand for wealth creation through savings is “compound interest”.

Compound Interest
Having a basic understanding of how compound interest works is important. With compound interest, the amount of interest you earn each year is added directly to your principle. This allows this interest amount to be included when calculating interest in future years.

For example, say you deposit $1000 into a savings account with a 7%t interest rate, and you do not touch this money or make any other deposits. At the end of the year, your money will earn 7% of the principal amount invested or $70.00 (7% x 1000). You now have $1070 in your account. At the end of the next year, you will earn another 7% on $1070 or $74.90 (7% x 1070). Now you have a total of $1144.90 in your account.

While this may not seem like a lot, over time this will really add up. For example, if you let this money sit in the account for 10.3 years without touching it, your money will double. An easy way to calculate this figure is to use The Rule of 72. By dividing 72 by whatever your current interest rate is, you will get the number of years it takes to double your money.

While this may not sound like much at first, this does not include any additional funds you may add to your savings account. Lets say that you add $40 a month to your new principal above of $1144.90 for the next 20 years at 7%, you would receive a total of $25,461 in the 20th year – that equates to $14,716 in interest made.

Use this compound interest calculator to look at other potential earnings based on different deposits, interest rates and length of time.

When looking at opening a savings account, its important to have an idea of what you are trying to achieve. Are you creating an account for the long, mid or short term? Regardless of your purpose for saving, a savings account is a great vehicle to help you achieve your financial goals.

Below are a few other things to be mindful of when it comes to savings accounts.

Things to Watch Out For
Not all savings accounts are created equal and what seems to good to be true is often not.

- Fees, charges, and penalties. These are generally based on different balance requirements, early or number of withdrawals and transfers.
- Teaser rates where banks will advertise great initial rates which then change to a less favorable rate after a certain period (fixed for a period and then changes)
- Certain accounts may have penalties for depositing to much or missing a required monthly deposit

Using a compound interest calculator you can quickly determine the type of money you can earn based on rate, deposit(s) and time. The one thing a calculator can’t do is make sure you adhere to the terms of the account you open. It is really important to read the fine print (terms) carefully and be comfortable with the terms you are agreeing to, to ensure your reach your savings goals.

 

Image courtesy of renjith krishnan / FreeDigitalPhotos.net

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