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While this amount might still fall short of your goals, you’d be in a position to take advantage of Social Security as well.
How compounding affects what you owe
Compounding can be a wonderful gift and help with your retirement planning. But it can also be an albatross on your neck if you have any loans or credit cards with compound interest. The accelerated growth and snowballing interest can make it challenging to pay off debt, like two steps ahead, one step back.
Say you have $10,000 in credit card debt at 20% APR. It would take you 60 months (or five years) of $266.67 monthly payments to pay off the balance, and you’d end up paying $5,823.55 in interest over that time — about 37% of your total payments.
If you added $500 to the minimum payment and put $766.67 to your credit card balance each month, it’d take just 15 months to pay off the balance and you’d pay $1,369.33 — or about 12% of your total payments — in interest.
Just as compounding can accelerate your savings and investments, it can also make your debt balloon to unmanageable levels if you’re not careful.
Dig deeper: I’m a financial expert: Here are my 4 top tips for paying off your credit card debt
How often do accounts and balances compound?
When looking at how compound interest works, a major component of that is the compounding frequency. Different financial products apply different compounding frequencies, as you can see in the chart below.
However, these frequencies are only a benchmark and can vary by bank or creditor, so it’s always a good idea to check yourself. Something to note is that while savings accounts and credit cards might compound daily, the payout or charge is applied monthly.
Type of account | Typical compounding frequency |
Savings account | Daily |
Money market accounts | Daily |
Certificates of deposit | Daily or monthly |
Investments | Varies |
Loans | Monthly |
Credit cards | Daily |
How to take advantage of compound interest
Knowing what compound interest is and how compounding works are one thing. Taking advantage of it is another and requires action on your part.
Here’s how to take advantage of compound interest:
Start right now. No matter where things stand with your savings and investments, start where you are and continue to set aside money. Time is what makes compound interest grow into something substantial.
Know your rate of return. For many savings products, rates are expressed as an annual percentage yield, or APY. Your APY already has the compounding frequency baked into it and shows how much interest you’ll earn in a year’s time. Your interest rate doesn’t include compounding and determines the amount of interest you’ll accrue on your principal balance.
Review your compound frequency. Compounding frequency can change based on the type of account and financial institution. You’ll get the most benefit from frequent compounding. That can come in handy if you’re shopping around for different types of accounts.
Stick to it. Imagine your retirement funds are like a lush garden that needs watering. In this case, you can keep your retirement funds healthy and growing by consistently adding to your account. Even if you put away less in some months than others, the point is to continue building the habit and taking advantage of how compounding works.
What to know about compound interest and taxes
Compounding works to grow your savings and investments, but be aware that much of the interest you’ll receive is taxable income in the eyes of the Internal Revenue Service (IRS).
“Interest earned on savings accounts, bonds and CDs is taxed as ordinary income, which can chip away at your gains,” says Tyler Meyer, a certified financial planner and founder of the blog Retire to Abundance. “However, tax-advantaged accounts like IRAs and 401(k)s allow you to defer taxes, so your money can grow without the IRS taking a cut until you withdraw it. With a Roth IRA, your investments grow tax-free, provided you follow the rules, which can make compound interest even more beneficial.”
Dig deeper: How all 50 states tax retirement income: A comprehensive list
FAQ: Savings, investing and planning for retirement
Compound interest can multiply your money to grow your savings faster. Learn more about how to save, invest and plan for a comfortable retirement.
I’m retired. What low-risk investments should I look into?
It’s not realistic to think you can invest your money with zero risk. However, there are several accounts and assets that can help you grow your money while minimizing the impact of the market’s ups and downs on your retirement funds, including high-yield savings accounts and CDs, mutual funds and Treasury bonds. Start with our roundup of the best low-risk investments for steady gains in your golden years, including tips for new investors.
I’ve saved up $10,000. Where’s the best place to put it?
Saving up $10,000 is an impressive milestone that opens up several financial opportunities that can better position you for a more stable financial future. You can put it to work through passive income streams, contribute to growing a retirement fund or pay down high-interest debt. See our guide to the five smartest moves to make with your $10,000.
Can I have more than one savings account?
Yes, you can have more than one savings account. While some banks may limit you to one account, you can always open new accounts with other banks. This can help you spread out your money, benefit from different perks each bank offers and even access more FDIC coverage to protect what you earn. Stay on top of banking benefits, products and news to find what works best for you.
Should you keep more than $250,000 in one bank?
It’s not a good idea to keep more than $250,000 in a single bank account if there’s just one person listed as the account owner. This is because you’ll exceed FDIC limits — meaning any amount over $250,000 could be at risk if the bank were to fail. If you have a joint account, you can keep up to $500,000 in a single bank account, because the $250,000 limit applies to each of you. Of course, if you have a cash management account or DIF coverage, your limits might be higher. Learn expert rules of thumb about how much you should keep in a savings account, in a certificate of deposit and in a checking account.
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About our writer
Melanie Lockert is an L.A.-born and Brooklyn-based freelance writer with a decade of experience in personal finance. Melanie started the Dear Debt blog in 2013 and chronicled her journey out of $81,000 in student loan debt. She published a book of the same name in 2016. Her personal finance expertise has been featured on Fortune Recommends, CNN Underscored, Yahoo Finance and Business Insider, among other publications. She is also the host of the Mental Health and Wealth Show and cofounder of the Lola Retreat, a finance event for women.
Article edited by Kelly Suzan Waggoner
