Next, learn how to calculate how much you'll earn over 1 year when you invest with these banks.
Here is the formula:
FV = P(1 + i)^n
FV = the future value of your investment
P = your principal investment
i = the interest rate
n = the number of years invested
By multiplying your interest rate times your principal, you'll calculate how much interest you’ve earned. But to know the final amount or your total value, you’ll need to know the interest amount plus the amount of your principal!
Example: If you earn 5% on $100 over 1 year, you have: 100(1 + 0.05)^1= $105
Now, assume you’re starting with a $5,000 investment that you earned by mowing your neighbors’ lawns for the last few years. Based on the percentage rates at your local bank for a Savings, Money Market, and CD accounts, how much would each account earn you over a period of one year?
From the equation above, you can tell that the amount you make compounds exponentially over each year. What is the difference in the actual values?
Here are some examples based on the current gloomy rates of mid-2009:
Savings (0.1% APY)
One year: 5,000 (1 + 0.0001) = $5000.50
Three years: 5,000 (1 + 0.0001) 3 = $5001.50
Five years: 5,000 (1 + 0.0001) 5 = $5002.50
Money Market (1% APY)
One year: 5,000 (1 + 0.01) = $5050.00
Three years: 5,000 (1 + 0.01) 3 = $5151.50
Five years: 5,000 (1 + 0.01) 5 = $5255.05
CD (5% APY)
One year: 5,000 (1 + 0.05) = $5250.00
Three years: 5,000 (1 + 0.05) 3 = $5,788.13
Five years: 5,000 (1 + 0.05) 5 = $6,381.41
Notice how much difference just a few percentage points can make over time? Now imagine that when a high-schooler becomes an adult with a full time job, he will be investing much larger amounts, and hopefully at larger percentage rates.