How do Banks calculate daily interest paid monthly?

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Forums › Finance and wealth management › How do Banks calculate daily interest paid monthly?

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sleemanj

1490 posts

Uber Geek

#884025 24-Aug-2013 21:09

joker97: Surely that would make it wayyy mare than 4.07 perecent from the compounding?

No, not at all f you deposit $1 at 4% PA, compounded daily, you come out with 1.04069.... at the end of the year.

https://docs.google.com/spreadsheet/ccc?key=0ArNRgk3zdvv3dFlKZVhqS1FKTXNlU1lCMkJ2WGF1Rnc&usp=sharing

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James Sleeman
I sell lots of stuff for electronic enthusiasts...

geek4me

843 posts

Ultimate Geek

Trusted

Lifetime subscriber

#884132 25-Aug-2013 09:50

No matter how it's calculated compounding interest is not going to make you that much richer as the cartoon shown earlier aptly showed.

"If the interest rate is compounded annually it will be $1,219. If it is compounded monthly it would then be $1,221.20"

Lets assume the interest was compounded daily 365x would that make much difference? You would then have $1,221.40, only 20 cents more after 10 years. Try using compound interest calculators online.

After 10 years at 2% you are only $2.20 (or $2.40) better of. You've waited 10 years and the monthly (or daily) compounding additional interest won't even buy you a cup of coffee! You're better of "trying to make more money", or try and increase the original interest rate by 0.1% that will increase the return more than the compounding interest would.

While every penny helps, monthly or daily compound interest is a bit overrated. It sounds good but you won't be that much better of in the short term. Ask the Bank for an extra 0.1% instead.

Edit: added "monthly or daily" to the last paragraph.

crimson

22 posts

Geek

#884396 26-Aug-2013 00:44

geek4me: "If the interest rate is compounded annually it will be $1,219. If it is compounded monthly it would then be $1,221.20"

Lets assume the interest was compounded daily 365x would that make much difference? You would then have $1,221.40, only 20 cents more after 10 years.

Out of interest (excuse the pun), if continuous compounding was used in the example (this means breaking down the compounding intervals to infinitely small periods), you would also have $1,221.40 (it is 1221.403 continuous vs 1221.396 daily)

Byrned: Why is the interest not paid daily? Because then it would be compounding and cost the bank more money.

There is a pretty good reason why they wouldn't (and shouldn't) pay interest daily, rounding and admin. Every day you would be rounding the interest payment and the withholding tax payment as you can only pay whole cent increments each day. Think of your bank statement with 60 transactions a month just for interest and tax...

At the end of the day, banks set their rates to which ever interest payment method is used. I recall The National Bank (was a good 5-6 years ago) advertising a 2 year term deposit, interest paid on maturity. So while it had a higher rate, not compounding over 2 years made it a pretty crappy deal (but great advertising).

Rabodirect use daily compounding (well week daily!) on their Cash Advantage Fund accounts.

MaxLV

656 posts

Ultimate Geek

#884401 26-Aug-2013 02:15

crimson:
geek4me: "If the interest rate is compounded annually it will be $1,219. If it is compounded monthly it would then be $1,221.20"

Lets assume the interest was compounded daily 365x would that make much difference? You would then have $1,221.40, only 20 cents more after 10 years.

Out of interest (excuse the pun), if continuous compounding was used in the example (this means breaking down the compounding intervals to infinitely small periods), you would also have $1,221.40 (it is 1221.403 continuous vs 1221.396 daily)

Byrned: Why is the interest not paid daily? Because then it would be compounding and cost the bank more money.

There is a pretty good reason why they wouldn't (and shouldn't) pay interest daily, rounding and admin. Every day you would be rounding the interest payment and the withholding tax payment as you can only pay whole cent increments each day. Think of your bank statement with 60 transactions a month just for interest and tax...

At the end of the day, banks set their rates to which ever interest payment method is used. I recall The National Bank (was a good 5-6 years ago) advertising a 2 year term deposit, interest paid on maturity. So while it had a higher rate, not compounding over 2 years made it a pretty crappy deal (but great advertising).

Rabodirect use daily compounding (well week daily!) on their Cash Advantage Fund accounts.

When your savings account terms and conditions say the interest is calculated daily, and paid monthly it does mean the interest is effectively being paid daily. The paid monthly bit just means that's when the daily interest is calculated and credited to the account.

In the monthly calculation, interest earned each day is added to the account balance each day, and included in the account balance when the interest is calculated for the following days.

The monthly calculation is:

Balance x annual interest rate / 365 (daily rate) = account balance per day.

Simply spreadsheet calculator for 31 days @ 4%p.a.

$1,000.00 $0.11
$1,000.11 $0.11
$1,000.22 $0.11
$1,000.33 $0.11
$1,000.44 $0.11
$1,000.55 $0.11
$1,000.66 $0.11
$1,000.77 $0.11
$1,000.88 $0.11
$1,000.99 $0.11
$1,001.10 $0.11
$1,001.21 $0.11
$1,001.32 $0.11
$1,001.43 $0.11
$1,001.54 $0.11
$1,001.65 $0.11
$1,001.75 $0.11
$1,001.86 $0.11
$1,001.97 $0.11
$1,002.08 $0.11
$1,002.19 $0.11
$1,002.30 $0.11
$1,002.41 $0.11
$1,002.52 $0.11
$1,002.63 $0.11
$1,002.74 $0.11
$1,002.85 $0.11
$1,002.96 $0.11
$1,003.07 $0.11
$1,003.18 $0.11
$1,003.29 $0.11

As its to only 2 decimal places it's not all that accurate. Bank calculations would use more decimal places, and probably round up and down each day.

Of course theres alway the savings calculators all banks have on their websites to use.

crimson

22 posts

Geek

#884403 26-Aug-2013 03:09

MaxLV: When your savings account terms and conditions say the interest is calculated daily, and paid monthly it does mean the interest is effectively being paid daily. The paid monthly bit just means that's when the daily interest is calculated and credited to the account.

In the monthly calculation, interest earned each day is added to the account balance each day, and included in the account balance when the interest is calculated for the following days.

Not correct. That's what happens (by definition) when it says interest compounds daily and paid monthly.

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