Whether saving money for a short-term or a long-term goal, you want to earn the maximum returns from your savings account. To do this, you must understand how financial institutions and saving instruments calculate and pay interest beyond the advertised rate.
Interest is the money a bank or financial institution pays you to keep your money in a savings account. However, not all interest is the same. The frequency at which interest is calculated, compounded, and added to your savings can significantly impact the overall returns your savings generate.
One way to ensure you earn maximum returns is to look at your savings account's interest accrual period. The frequency of accrual affects the overall amount of interest earned on savings. Choosing the right accrual frequency can impact the interest earned and help you achieve your savings goals faster.
This article will explore the details of interest accrual, why it matters, and the different types of accrual periods, including daily, monthly, quarterly, and annual accrual. Using the Absa Digital Savings Account as a case study, we’ll explore how you can leverage interest accrual to maximise your savings returns.
Interest accrual refers to the frequency at which interest earned is added to your savings account.
When you put money in savings accounts, it starts accumulating interest. Depending on the type of account, interest will accumulate at different periods. Some banks will calculate interest based on your daily account balance, others on the average monthly balance, others on your average quarterly balance, and others on your average annual balance.
However, this interest isn't typically added to your account as you earn it. For instance, your account can accumulate interest daily, but it will be added to your account at the end of the month. Or it can be accumulated monthly but added at the end of the year.
Therefore, if interest is accumulated and added to your account daily, your account offers a daily accrual interest.
Accrual interest is based on the account balance and annual percentage rate (APR). Therefore, to calculate it, you multiply the APR by your account balance.
If your account offers a 5% p.a. interest rate and you maintain a balance of Ksh100,000, your accrued interest will be:
5% x 100,000
This means at the end of the year, your savings will earn you Ksh5,000. The interest is calculated and added to your savings account only once a year.
If you had the same amount in a different account offering quarterly, monthly, or daily accrual interest, your returns would be added to your account at different periods.
For quarterly, the calculation will be:
Which is Ksh1,250 - That much will be added to your account every three months. The interest is calculated and added to your savings account at the end of every quarter.
For monthly, the calculation will be:
Which is Ksh416.67 - That much will be added to your account monthly. In this scenario, interest is calculated and added to the account every month, usually on the last day of the month.
For daily, the calculation will be:
Which is Ksh13.7 - That much will be added to your account daily. Interest is calculated and added to the account daily. Typically, this means interest earned on the account is based on the account balance at the end of each day.
As you have noticed, the total amount at the end of the year doesn't change. What changed is the interval at which interest is added to your account. If you have a fixed account earning Ksh13.7 at the end of a 365-day calendar year: you'd have earned Ksh5,000, which could have been the same if it was paid at the end of the year.
NOTE: Accrual interest only becomes important when it works with compound interest.
But before we look at how interest accrual and compound interest relate, you should know that there are other accrual periods, such as weekly, biweekly and semi-annually.
Some saving instruments can also slice time more to reduce the accrual frequency below daily, although this is rare. And others, like fixed deposits, will pay interest at maturity or an agreed interval. But unlike traditional savings, you'll know your expected returns from the very beginning.
Interest accrual is different from compound interest. While interest accrual refers to regularly calculating and adding interest to an account, compounding is earning interest on the original deposit and any interest already earned and paid. The frequency of interest accrual and compounding can vary independently of each other.
Some savings accounts, such as the Absa Digital Savings Account, offer an interest accrual option matching the compounding frequency. The account pays out all accrued interest at the end of a quarter and compounds your interest at the same interval.
However, interest is earned on your daily outstanding balance – more on that below.
It's important to understand the difference between interest accrual and compounding when choosing a savings account. Ideally, you would want a savings account that accrues interest frequently and compounds it as often as possible to maximise your earnings.
A savings account that offers daily interest accrual and daily compounding would offer one the highest possible total interest earned over time. However, in Kenya today, there is no savings account that offers this option.
As the name suggests, the Absa Digital Saving Account is a savings instrument offered by Absa and is completely online. Unlike traditional savings accounts, you can open an Absa Digital Saving Account from anywhere in the world through your phone or computer and start saving without visiting a bank.
Unlike traditional bank accounts, the Absa Digital Saving Account offers attractive interest accrual frequency and rates that ensure you can maximise your returns. When you save money on this account, you earn interest on your daily outstanding balance.
With Absa Digital Savings Account, interest accumulates daily but is paid at the end of every month. Additionally, interest is compounded monthly. This means you will be able to earn interest on your interest the next month– granted, you didn’t withdraw it.
Since the interest accrual and compounding frequency are monthly, you can enjoy the benefits of compound interest as opposed to when interest is paid annually.
This tiered interest structure and daily accrual offer three main benefits:
Interest accrual not only impacts your savings accounts but also affects your loans. Common sources of daily interest accruals are credit cards and mortgages.
In the former, interest is accrued daily, while in the latter; it is monthly. This means that if you have a credit card balance, you will accrue interest on the daily outstanding balance, and if you have a mortgage loan, you will be incurring interest on the outstanding monthly balance.
The frequency of interest accrual and compounding can vary depending on your lender and the terms of your loan. Some loans may have the same frequency for both accrual and compounding, while others may have different frequencies. For example, a loan may accrue daily interest but compound it monthly or annually.
When borrowing, it is generally more beneficial to opt for loans that accrue interest less frequently, such as monthly or yearly, instead of daily. This is because less frequent accrual and compounding periods can result in lower overall interest costs for borrowers. With daily accrual and compounding, the interest can add up quickly, resulting in higher interest expenses over time.
Understanding the frequency of interest accrual and compounding is crucial when choosing a savings account. Daily accrual and frequent compounding, such as quarterly, monthly or even daily compounding, can result in higher total interest earned and faster savings growth. Therefore, when opening any saving account, always inquire about interest accrual from the financial institution.
While interest accrual is vital, it isn’t the only thing to pay attention to. Consider all the factors, including interest rates and fees, when choosing a savings account that aligns with your financial goals. Always review and understand the terms and conditions of any savings account before opening one.