For example, do you want to save enough money over several months or years to pay for a special event like a major vacation, a college degree, a wedding, or a new vehicle? People have all kinds of financial goals, some short-term, some long. Plus, their targeted savings amounts vary greatly, from less than $100 on the low end to many thousands of dollars.

Here are the general steps for turning your savings dreams into reality.

Make a General Plan to Save Money

Decide what you are saving for and write down a general plan to get started. For instance, if you want to buy a used car for cash, research prices and acceptable models to get an accurate idea about how much money you’ll need. Perhaps you realize that the kind of car you want will cost $8,000, and you want to purchase it in 36 months. Take a look at your budget and include a set-aside amount from every paycheck.

Regardless of what you’re saving for, it’s imperative to know how much time you have, how much money you want to accumulate, and whether you can afford the expense. Buying a new home for cash is probably out of the question for most people. However, financing a vacation two years down the road is often a practical goal.

Use a Compound Interest Calculator

Using a simple interest calculator is, as the term implies, simple. Here’s a good one that lets you put in the primary data and arrive at a result relatively quickly.

To use it, you only need a few figures, like the account’s interest rate where you’ll be putting the deposits, the amount you will deposit at each interval, and the number of contributions from beginning to end.

As an example, which we’ll walk through below, suppose you examine your budget and feel comfortable saving $250 per month for a trip, vehicle, or major appliance. Here are the steps for using the calculator to arrive at a total amount you will have in the account after interest and all contributions are accounted for.

• One: Include a starting balance if you have one.
  Realize that many people have a zero beginning balance, but if you have some money in the account already, be sure to put it on the first line of the calculator’s input page. For our example, we will assume a starting balance of $500.
• Two: State the annual interest rate.
  Note that sometimes this figure will be an estimate. For savings and CD accounts, though, it’s typically a specific number. For example, assume an annual interest rate of 5 percent for this hypothetical case.
• Three: Enter the compounding frequency.
  Keep in mind that you might receive monthly, daily, or annual compounding. Assume “monthly” for our test case.
• Four: Enter the length of time.
  This refers to the total number of months, from now, that you will be adding money to the total.
• Five: Enter the payment, whatever it is.
  As noted above, we assume a $250 monthly contribution, which will be our “payment” amount.
• Six: Enter “Payment frequency,” which is monthly in this example, meaning you’ll be making deposits of $250 every month for the life of the program.
• Seven: List the start date.
• Eight: Click on “calculate now” when you’re ready and have filled in all the information. If you left something out, enter it now. If you made an entry error, correct it. When you’re done and want to do another calculation, click on the “Reset values” button, and a new page will appear.

Our Results

In the hypothetical case, where we deposited $250 per month, with a $500 beginning balance, a 5 percent interest rate compounded monthly, and three years of deposits, our final account balance is $10,269.07, which means we can easily buy the $8,000 car we are saving for. So even if inflation causes the price of similar used cars to rise between now and then, we’ll still have more than enough cash to buy one.

Note that in the “Results” panel below the input section, you can see that you made $769 in interest on your monthly contributions and the $500 in the account at the beginning. If you had put the contributions into a cookie jar or safe, you would only have ended up with $9,500 instead of $10,269.

Doubling your savings each day works out to $0.64 at the end of the first week. By the end of the second week, you are looking at $81.92, and these exponential savings will yield more than $20,000 when the third week finishes. Once you reach the end of the month, your account balance will reflect more than $5.3 million. This is clearly a fantasy scenario.

A Realistic Scenario for Savings Strategies

The math does not lie with this savings strategy, but the practical reality of this hypothetical situation is that not many of us can generate the kind of income needed to make it to the middle of the third week. Even if you are an active investor, it would be very difficult, if not outright impossible, to generate 100% profits on a daily basis. Major Wall Street investors are not able to generate more than 20% daily gains with a diversified portfolio and a team of professional analysts and fund managers.

A more realistic savings strategy that could perhaps be taught to high school students is compound interest with actual rates, longer investment horizons, management fees, and capital gains taxation. Even the aforementioned penny-doubling example would fail to make even a million dollars in a month.

Real Talk About Compound Interest

Compounding is an investing strategy that wealthy families and investors masterfully use, but it is actually open to just about anyone who wishes to take advantage of it. Billionaire investor Warren Buffett is probably the best example in this regard; approximately half of his $100 billion net worth has been generated through compounding, which he has strictly adhered to since his early teens. This is the number one real-life rule of compound interest: The earlier you get started, the more wealth you will be able to generate.

As previously mentioned, there is simply no way you will be able to double your deposits on a daily basis constantly. The reality of compound interest accounts in 2021 is that even the highest rate you will find is less than 1% in the United States. The best you could hope for in October 2021 was 0.60% for a high-yield savings account or 0.55% for a money market account. These are the rates you should input when using our Compound Daily Interest Calculator, and we will use one of them in our example below:

• You start out with a $100 deposit plus a commitment to set aside $5 each day towards a contribution. 
• Your compounding rate of 0.60% will be applied daily, and the bank will take care of reinvesting profits for you. 
• In one year, you would have more than doubled your investment to $230.42, and your investment will not be taxed at the high 30% capital gains rate because it is a savings account. 

You can also adjust the parameters of the compound interest calculation according to your means and investing horizon. For example, if you are able to contribute $150 each month to your compounding account, you would generate $18,657 in 10 years.

Compound interest can also serve as an excellent tool for financial retirement planning. For example, if you start compounding at the age of 20 and stick to the savings plan above, you would have $86,106 by the time you are able to claim your Social Security pension.

The Importance of Money Management and Disciplined Contributions

Becoming a millionaire from your compound interest strategy is possible, but it will require more effort than the examples cited above. The contributions you make to the account are the keys to financial success. Instead of sticking to $5 a day for life, you should always look for opportunities to increase these amounts. Salaried employees and wage earners can do this whenever they get raises and bonuses. Active traders should be depositing profits that they realize from the base amount they use to take market positions; in fact, many online retail brokers offer compounding accounts, typically of the money market kind, where clients can let their money grow in a passive manner.

As for money management, you can’t beat a compound interest strategy. All investors and savers should have a supply of emergency cash that would cover three months’ worth of household expenses in case of emergencies; compounding accounts are the best accounts where you can keep these reserves because you know that you will not be making withdrawals too often, only when there is a pressing need to do so. Even if you only withdraw half of these reserves when you are in between jobs, the rest of the money should earn compound interest as you get back on your feet and start replenishing the emergency fund.

Traditional Savings Accounts for Your Emergency Fund

Financial planners stress the importance of having an emergency fund of at least three to six months stashed somewhere that is easily accessible, but not in your checking account. Savings accounts are a popular place to stash cash because you can quickly withdraw it if the need should arise, but it is out-of-sight and out-of-mind when a tempting impulse purchase comes along. An emergency fund is an essential part of protecting your investments. It can help you handle the minor mishaps in life that occur, such as car repairs, medical expenses, or home repairs, without having to get money from your retirement account. 

Withdrawing money early from your retirement account can cause you to incur hefty fees, and some accounts will not even allow early withdrawals. In addition, early withdrawal from your higher-interest retirement account means that you miss out on the interest that money could have earned in the future, too. That is why having a separate emergency savings account is so important, but there is no reason why you should not allow it to grow, too. Even though savings accounts do not offer as high interest as other investments, at least your money is growing while it is on standby in case of an emergency. 

Choosing a Savings Account

When choosing a savings account, many people only look at the annual percentage yield (APY). While this is important in getting the most for your money, other factors can have a more significant impact on savings growth. For example, most banks are currently at an APY of around 0.50 to 0.60%, which is not as attractive as the average 7% that you could earn in the stock market. 

The first thing to make sure is that the bank offers compound interest so that you will earn interest on the interest, allowing your account to grow more quickly over time. One thing to watch out for is that some banks will advertise higher rates to draw you in, but these rates are for simple interest and not compound interest. This means that you will not earn interest on the interest, only the initial interest that you deposit. So even though the interest rate sounds higher, you could earn less over time than with a compound interest savings account at a lower rate. 

Another thing to watch out for is teaser rates. This is where the bank offers a higher interest rate for a certain period, and then the rate is reduced. An additional factor that you need to watch for with teaser rates is that sometimes, they will make you agree to keep your money in their bank for a certain amount of time to earn the higher rate. They often will not pay out the higher interest rate until you have met the minimum deposit length of time requirements. You cannot just get the higher interest and then move your money after the regular rate kicks in without a penalty. 

Understanding Compound Periods

The compounding period is one of the most important things to understand when choosing a place to stash your emergency savings. This is how often the interest earned is calculated. Many regular savings accounts may compound the interest monthly, but some compound it daily. Some banks offer money market accounts and CDs that compound daily. 

The bottom line is that compounding daily earns you much more money than compounding monthly because the interest money is added to the account and begins earning interest more often. To see the difference, you can use this compound interest calculator. Switch the “compound frequency” from monthly to daily, and you can see just how much difference there is.

Suppose you want to see what you would earn in a simple interest account at a higher rate as compared to compound interest at a lower rate. In that case, you can use the compound interest calculator and compare it to the results you get with this simple interest calculator. 

As you can see, there is more to deciding which savings account will be the best place for your emergency savings than just looking at the advertised APY. You have to compare the type of savings and know how often it compounds. Therefore, it is always best to make sure you thoroughly read the documents before signing up for a savings account for your emergency fund.