Wouldn’t it be cool if you could make money while you sleep? Believe it or not, you can! All you need to do is save some of your money by depositing it into a bank account that pays interest.

Interest is money the bank pays you for the privilege of keeping your money safe. To understand how this works, let’s learn the difference between banks that pay no interest and those that pay either simple interest or compound interest.

For example, let’s say you put $100 in your piggy bank. Over time, if you don’t spend any of it, you’ll still have $100 in your piggy bank, right?

Because your piggy bank is not a real bank account, it doesn’t pay you interest. It just holds your money, which doesn’t grow over time. You’ll always have exactly the same amount you started with.

Instead, let’s say that you deposit your $100 into a bank account that pays simple interest quarterly. Your $100 is called the “principal.” “Simple interest quarterly” means the bank pays simple interest on your $100 four times a year.

If your bank pays 5% interest, that means every three months (quarterly), the bank pays you $5 (5 percent of your original $100) in simple interest. After a year, you’ll have $120 ($100 — your principal — plus $5 for each quarter in the year).

You don’t even have to go down to the bank to collect your simple interest. The bank puts that money right into your account!

Simple interest is a pretty good deal. You get paid $20 just to leave money in a bank account.

But there’s an even better deal! Let’s see what happens when your bank pays compound interest.

Compound interest is very similar to simple interest. The difference is that instead of paying interest on your original $100 every quarter, the bank instead will add each interest payment to the principal.

That means you end up earning interest on your interest. When this happens, bankers say your interest is “compounded.”

Let’s do some math to see the difference this makes. You start with $100 in a bank account that pays 5% compound interest, quarterly.

At the end of the first quarter (three months), the bank pays you $5 (5 percent of $100). Your new principal balance is $105.

At the end of the second quarter, the bank pays you 5% interest again. This time, though, it pays interest on your principal balance of $105.

Since 5 percent of $105 equals $5.25, the bank adds $5.25 to your account. Your principal balance goes up to $110.25 ($105 plus $5.25 in compound interest).

If you do the same math for the third and fourth quarters, you’ll find that your principal balance at the end of a year is $121.55.

With 5% simple interest, you had $120 in your account at the end of a year. With 5% compound interest, you earned an extra $1.55.

As you can see, compound interest helps your money grow faster because it pays interest on your interest over time. That extra $1.55 may not sound like a lot of money right now, but your account has only earned compound interest for one year.

The more money you put in your account, the more interest the bank will pay. The longer you leave your money in your account, the more compound interest it will earn over time.

Some people wonder where banks get the money to pay interest. After all, if the bank keeps your money safe, shouldn’t you pay it for such a service?

The reason banks can pay you interest is because they use your money — and everyone else’s money — to invest in things like stocks, bonds and mutual funds.

The bank makes money (profit) on those investments. It then pays you compound interest out of those profits.

 

30 Join the Discussion

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  1. Are you sure it’s possible to earn interest quarterly? I don’t know of many banks, if any, that will pay 5% or even 1% every 3 months. Most offer an annual interest–which is simple or compound. Your calculations will make students anticipate that they can actually make $20.00 to keep their $100. in a bank for a year. They will be sadly disappointed. Your online calculator creates a more accurate picture–approximately $5.00 will be their reward for their efforts to save.

    • Hi, Sharon! Thank you for your comment today! There are many banks that offer quarterly interest on savings accounts. We really appreciate your concern for how the young visitors to this Wonder will view compound interest and for pointing out that you feel the online calculator provides a more accurate picture of what savers can expect for their efforts! :-)

    • We’re super sorry, JoJo. Is there something you’d like to know more about after exploring today’s Wonder of the Day®?

  2. We think this is a great idea. We can save money by putting it in our own accounts, but first we think we need to earn money. To earn money we have to earn allowance by sweeping the floors, making our beds, washing the dishes, cleaning after our pets and ourselves, and doing our HOMEWORK! We really liked the video. It helped us understand and think of saving our money. :)

    • Those are GREAT ways to earn money, Mrs. Jarvis’s Second Grade! Plus, they are also awesome ways to help around the house (even if we didn’t do them to earn allowance)! We’re glad today’s Wonder got you thinking about money and ways to earn and save it! We’re also glad you like the video! :-)

    • Something tells us you like video games, Cole! It is good to save up for something you really want (like video games), because you learn the value of your hard-earned money! :-)

    • Yes, we have heard about that, Noah. It’s sad. Sometimes, when we’re feeling sad about something like this that we hear about in the news, it’s best to talk to a grown-up (like a parent or teacher) about it. They can help us work through our feelings or even just sit and listen to us about how we feel.

      We hope you have an AWESOME day and we’re really glad you’re a friend of Wonderopolis! :-)

    • We’re pretty sure it would take a lot of savings to buy an Audi, Noah! We think that is a GREAT goal to save for now, though, so that when you are older, you can purchase the type of car you like! :-)

  3. We were interested in learning how putting our money in the bank can help us earn more money. Thanks for making it easy to understand.

    • Hello, Mrs. Glasgow’s class! Thanks so much for leaving us this awesome comment today and for letting us know you learned something new about earning interest! You are GREAT Wonder Friends! :-)

    • Money is a great gift to get at any time of the year, Lily! Thank you for sharing this comment with your friends in Wonderopolis today! :-)

  4. Hi, Wonderopolis!!! I love this wonder! I know this is just a random suggestion for a wonder, but I have always wanted to know if Santa is real. Can you please do a wonder about that, please?!!?? :)

    • LOTS of Wonder Friends WONDER about that question, Maria! Thank you for suggesting that it be a future Wonder of the Day®! :-)

    • Hi, Muhammad! We’re glad you visited Wonderopolis today! We hope you’ll keep checking back…we’ve got something new to WONDER about every day! :-)

  5. I am familiar with banks that pay quarterly interest on savings, but I think the interest rate used is very high, I am lucky to earn 1 or 1.5% on my savings.

    • We’re happy to hear you are “hooked” on Wonderopolis, Wonder Friend! Learning new things every day is fun and exciting…it’s like scoring points for your brain! :-)

    • That’s an AWESOME question, love WONDERopolis (we like your name a lot!)! Thanks so much for visiting us today and suggesting an idea for a future Wonder of the Day®! :-)

  6. I was wondering, what are some suggestions for becoming a millionaire? A realistic way to start saving and earning until you get to be a millioniare plus some saving and earning tips would be really helpful!! Thanks for all the helpful information on this site. Also, you guys should do a wonder of the day on ways to start your own business, even if its just a lemonade stand. Thanks, Wonderopolis!

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Have you ever wondered…

  • What is compound interest?
  • What’s the difference between simple interest and compound interest?
  • Where do banks get the money to pay interest?

Wonder Gallery

Try It Out

Ready to put your money to work? First, check with your parents to find out if the bank they use offers accounts that pay compound interest.

Next, look at how much money you earn each week from your allowance or chores. Decide how much of your money you want to set aside each week to deposit into a savings account.

You’ll need an adult to help you open a savings account. Make sure the account pays compound interest (not simple interest), and ask how frequently the interest will be compounded.

If you add a little bit of money to your account every week, you’ll increase the principal. In turn, this will increase the amount of compound interest you’ll earn.

Would you like to see how much compound interest you can earn over five, 10 or even 20 years or more? Try out this compound interest calculator.

 

Still Wondering

Use EconEdLink’s Big Banks, Piggy Banks lesson to explore how well different savings places achieve goals like protecting money and earning interest.

 

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