Understanding compound interest vs simple interest
Interest refers to the amount of money you can earn from the original amount in an account. Given time, your money will grow based on the interest accumulated. There are 2 types of interest: simple and compound.
Earning simple interest
With simple interest, you earn interest based on an amount you deposit, which is calculated at regular intervals and will usually be applied and paid out at the end of the investment period. The percentage is always the same, and your money grows when you add more money because you’ll be earning that percentage of interest on a larger amount.
Earning compound interest
With compound interest, you earn interest based on the amount in your account for the calculation period, and the interest you earn is paid back into your account to increase the total amount you’re earning interest on. Simply put, compound interest lets you earn interest on top of your interest, causing your money to grow exponentially without having to add to it.
It's important to note that this distinction does not refer to changes in the interest rate itself but only to the amount on which you’re earning interest.
Which is better?
Your investment goals and desired returns will determine which option is better suited to you. Generally, compound interest is a better option when you’re saving and investing since your money grows faster. However, you need to look at the frequency of interest earned, i.e. how often the interest compounds. An account offering simple interest might offer a higher interest rate and longer investment terms, which means you’ll likely end up with more money in the long term, but you’ll have less access to your funds while they’re invested.
Successful financial planning is about choosing the right investment solution to suit your needs, and understanding the type of interest you’ll earn is essential to this decision.
How do I know which one I’m earning?
Simple interest applies when interest is based on a single investment amount for a fixed period, while compound interest is based on your balance.
Examples of compound interest accounts include our tax-free investment accounts, PureSave Account and Flexi Advantage investment account that offer the ability to make additional deposits or reinvest your interest earnings.
Our Fixed Deposit investment account is an example of a simple interest account, helping you grow your savings at a fixed rate for a specific period. Accounts like this might only allow for a once-off investment, pay out interest at maturity or offer the option of paying your interest into another account.