Compound Interest: Daily vs Monthly Compounding Compared
Banks advertise different compounding frequencies. After running the numbers, I learned the difference matters far less than you might think. When I started comparing savings accounts, I noticed they all advertised different compounding frequencies. One bank compounded monthly, another daily, and a third continuously. The rates were similar, but the compounding terms varied. I assumed daily compounding was meaningfully better, but the math told a different story. Here is what I found when I ran the numbers, and why I stopped letting compounding frequency drive my account choices. The Compounding Formula and What Frequency Does The compound interest formula includes n, the number of compounding periods per year. Annual compounding means n equals 1. Monthly means n equals 12. Daily means n equals 365. Each time interest is compounded, it is added to the principal and starts earning interest itself. More frequent compounding means each small bit of interest starts working sooner. A = P * (1 + r/n)^(n*t) P = principal r = annual rate n = compounding periods per year t = years For 10,000 dollars at 5 percent for 10 years, the results by frequency are: annual gives 16,289 dollars, monthly gives 16,470 dollars, and daily gives 16,486 dollars. The difference between monthly and daily over 10 years is about 16 dollars. That is 1.60 dollars per year on a 10,000 dollar balance. Frequency n Effective Rate 10k at 5% for 10yr vs Annual Annual 1 5.