Case Study: The Lowdown on Saving Money and Earning Interest

Case Study: The Lowdown on Saving Money and Earning Interest

Saving is the practice of placing one’s financial resources away with the expectation of making a financial gain. When we save, we tend to consume less and place our financial resources in some type of savings account. Many banks require a minimum deposit in order to open an account. Depending on your desired access to the money in the account, this may help you determine whether or not you should place the money in a regular savings account or a certificate of deposit (CD) account.

 

Regular savings accounts have the greatest degree of access and pay the lowest rate of return – that is, interest.

 

CDs require that the money be in the account for a specified period of time (six months, one year, five years, etc.) and tend to pay higher rates of return. While you may still access the funds, access comes with a stiff penalty for early withdrawal.

 

Simple Interest vs. Compound Interest

Simple interest isn’t common these days, but it’s helpful to understand what it is in order to explain compound interest.

 

So what exactly is simple interest? It’s the interest that you earn on your original deposit amount only. For example, if you deposit $1,000 into a bank, and the bank pays five percent interest per year, you will earn $50 of interest. You simply multiply the original deposit amount by the interest rate to get the amount that you earn ($1,000 x 0.05 = $50).

 

Compound interest, meanwhile, is the interest earned on the original investment and on the previous interest that you earned. If we go with the previous example, if you deposit $1,000 into a bank, and the bank is paying five percent interest per year, you will still earn $50 of interest for the first year. But you then add the $50 to the original deposit amount of $1,000 in order to determine the amount of interest earned for the second year of investment ($1,000 + $50=$1,050). Therefore, you earn interest on your interest, in addition to interest on your original deposit.

 

Complete the Following Tables as Instructed

1. John deposits his money in a bank that pays 10 percent simple interest each year. Assume John keeps his money in the bank along with his new deposits each year, but takes out the interest that he earns.

Year Beginning Balance Amount

Deposit

New Balance

(Principal)

Interest Rate Amount Interest

Earned

Total
1 $0 $100 $100 10% $10 $100
2 $100 $100 $200 10% $20 $200
3 $100 $300 10% $30
4 $100 10% $40
5 $400 $100 10%

 

2. John deposits his money ($1,000/year) in a credit union that pays 10 percent compounded interest each year.

Year Beginning

Balance

Annual

Deposit

New Balance

(Principal)

Interest

Rate

Amount

Interest

Earned

Total
1 $0 $1,000 $1,000 10% $100 $1,100
2 $1,100 $1,000 10% $210 $2,310
3 $1,000 $3,310 10% $331
4 $1,000 10%
5 $1,000 10%

 

3. John deposits his money ($1,000/year) for 10 years. The interest rate is compounded at 10 percent.

Year Beginning

Balance

Annual

Deposit

New Balance

(Principal)

Interest

Rate

Amount

Interest

Earned

Total
1 $0 $1,000 $1,000 10% $100 $1,100
2 $1,100 $1,000 $2,100 10% $210 $2,310
3 $2,310 $1,000 $3,310 10% $331 $3,641
4 $1,000 10%
5 $5,105 $1,000 10% $611 $6,716
6 $1,000 $7,716 10%
7 $8,488 $1,000 10% $10,437
8 $1,000 10% $1,144
9 $12,581 $1,000 10% $14,939
10 $1,000 $15,939 10% $17,533

 

4. Franny deposits her money ($500/year) in a savings account that pays 10 percent compound interest each year.

Year Beginning

Balance

Annual

Deposit

New

Balance

(Principal)

Interest

Rate

Amount

Interest

Earned

Total
1 0 $500 10%
2 $500 10%
3 $500 10%
4 $500 10%
5 $500 10%

 

5. Clarissa deposits $100 into a certificate of deposit at a credit union that pays five percent compounded interest each year. The CD’s term is five years.

Year Beginning

Balance

Annual

Deposit

New Balance

(Principal)

Interest

Rate

Amount

Interest

Earned

Total
1 0 $100 5%
2 5%
3 5%
4 5%
5 5%

 

6. Clarissa allows her CD to roll over (it renews with the amount from year five). However, the interest has increased to six percent. The term for the rollover CD remains five years.

Year Beginning

Balance

 

Annual

Deposit

New

Balance

(Principal)

Interest

Rate

Amount Interest

Earned

Total
1 6%
2 6%
3 6%
4 6%
5 6%

 

7 – 10. Dolly, Holly, Molly, and Polly each received $100 on their 16th birthdays. They each opened new accounts and placed their money into different banks. All of the banks use compounding interest. Who made out the best?

 

7. Dolly’s bank gave a free calculator for opening an account and a complimentary coffee and donut.

Year Beginning

Balance

Annual

Deposit

New

Balance

(Principal)

Interest

Rate

Amount

Interest

Earned

Total
1 $0 $100 10%
2 10%
3 10%
4 10%
5 10%

 

8. Holly deposited $75 this year and $25 in the second year because she wanted to donate to a cancer fund. She was given her choice of fruit bars.

1 0 $75 10%
2 $25 10%
3 10%
4 10%
5 10%

 

9. Molly added $10 to her $100 in year five. She was given a free t-shirt and water bottle, both with the bank’s logo on it.

1 0 $100 10%
2 10%
3 10%
4 10%
5 $10 10%

 

10. Polly deposited only $90, but added $20 in the fourth year because she contributed to the hurricane relief fund. Her bank gave a set of pens.

1 0 $90 10%
2 10%
3 10%
4 $20 10%
5 10%

 

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