Linz FLY Project meeting

The second meeting of the FLY Partnership took place in Linz, Austria on the 16th & 17th April 2015. The FLY Project partners shown here, were involved in wide-ranging discussions related to the progress of the project so far and planning for the future activities and events. The partners also worked on fine-tuning the structure and content of the  E-Course, which is central to the success of the project and its overall target of increasing Financial Literacy in our three target groups.

Does it matters how often your interest rate is calculated or not?

Very often interest rate is declared as percentage on a yearly basis. So does it really matter how often it is calculated during the year or not?

1st case – once per year

While it might seem very complicated stuff it is really simple. Let us do the math in the case when interest rate is calculated once per year. Let’s say we have 1000 euro in a saving account which has an interest rate of 2% yearly. After one year the interest our account would have accumulated will be 1000+(1000×2%) equals 1000+1000×0.02 = 1000 + 20 = 1020 euro. In other words, after one year and interest rate calculated at the end of the year our account has earned 20 euro and the money available in the account will be 1020 euro.

2nd case – once per month
We take the same initial conditions – 1000 euro in the saving account with a yearly interest rate of 2%. Interest rate is calculated on a monthly base. In one year we have 12 months so the MONTHLY interest rate will be 2% divided by 12 or in mathematical representation 0.02/12 = 0.00166666 which we could simplify at 0.002. That is 0.2% monthly. So the interest rate is calculated monthly and the calculations are:
1st month: 1000+1000×0.002 = 1000+2=1002
2nd month: 1002+1002×0.002=1002+2.004=1004
3rd month: 1004+1004×0.002=1004+2.008=1006.01
4th month: 1006.01+1006.01×0.002 = 1006.01+2.012 = 1008.02
…..
11th month: 1020.18+1020.18×0.002 = 1020.18+2.0404 = 1022.22
12th month: 1022.22+1022.22×0.002 = 1022.22+2.0444=1024.27

In this case if we compute the interest rate on a monthly basis the same saving account would have generated 24.27 euro for one year compared with the 20 euro in the 1st case or 4.27 euro more on a yearly basis. That is roughly 20 percent more earnings.

As a conclusion: The more often the interest rate is calculated the higher the earnings at the end of the year will be. That is due to the compound effect accumulating over each calculation, as the interest rate is calculated over a higher amount that includes the interest earned the previous sub-period (in the second case it is a month). You can easily make the calculation if the interest rate is calculated on a weekly basis using the same initial conditions.