Short-term savings refers to money set aside for near-future expenses or goals, typically within a timeframe of a few months to a couple of years. These savings are often kept in easily accessible accounts like high-yield savings accounts, money market accounts, or short-term certificates of deposit (CDs). The primary goal of short-term savings is to balance liquidity with modest growth through interest earnings.
The Compound Interest Formula for Short-Term Savings
The formula used to calculate the growth of short-term savings with compound interest is:
\[A = P(1 + \frac{r}{n})^{nt}\]
Where:
\(A\) = Final amount
\(P\) = Principal amount (initial deposit)
\(r\) = Annual interest rate (in decimal form)
\(n\) = Number of times interest is compounded per year
\(t\) = Number of years
Step-by-Step Calculation Process
Identify the principal amount (P), annual interest rate (r), compounding frequency (n), and term (t).
Convert the annual interest rate to decimal form (divide by 100).
Divide the annual rate by the compounding frequency to get the periodic rate.
Convert the term to years if given in months (divide by 12).
Multiply the compounding frequency by the number of years to get the total number of compounding periods.
Apply these values to the compound interest formula.
Calculate the final amount (A).
Subtract the principal from the final amount to determine the interest earned.
Example Calculation
Let's calculate the growth of a short-term savings account with an initial deposit of $5,000, an annual interest rate of 2%, compounded monthly, over 6 months: