Perhaps one of the main reasons many do not save more is down to a lack of knowledge. Many of us do not understand the implications that saving can have on our overall financial health when interest is considered. Two factors help maintain that lack of knowledge. Firstly, the numbers behind figuring out what savings account is the best for you, with your specific circumstances in mind, is confusing. Secondly, it is not just the maths; it is the English behind savings accounts that can make them hard to understand.
Here, we set out a list of key terms that can make a novice saver flounder. Understanding them will help you make better, more informed decisions about where to put your money. You’ll be able to ascertain whether a savings account is all it's cracked up to be once you can comprehend the terminology that advertises it. These are only short summaries and definitions, however. We will publish longer, more detailed pieces that will further deepen your knowledge in the coming weeks.
Compound interest rate
Understanding what compound interest is, is a fundamental notion when it comes to savings accounts. That is because the interest earned on a savings account is calculated on a compound basis. In practice, that means that you do not earn interest on the amount you originally invested. Instead, you earn interest on the amount you originally invested and then the amount your investment has grown to. Or, to put it bluntly, compound interest is the practice of your interest earning interest. It is why savings accounts can build up so much over time.
APR stands for Annual Percentage Rate. You’ll see it a lot when it comes to comparison tables of loans or credit cards. Financial institutions use them to try to make their products easily comparable. Doing so allows you to see how expensive one product is compared to another. However, knowing what APR stands for and how it works is vital from the outset. APR is not only the interest rate charged on any borrowing; it is also any fees or charges that your lender adds to your bill. These can amount to a lot in some instances. For example, a credit card may appear to charge a low headline interest rate, like 15%. However, it may have a higher APR than a credit card that charges 17.5% as a base rate with no other charges.
When you know what your APR is on a loan or a credit card, you can then figure out more easily how that impacts your ability to save.
A nominal return is what you will earn on an investment or savings account before other factors are taken into account. It can be a quick, albeit crude, way of comparing returns across different investments to see how they have fared against one another. It’s a good measure of return across a wide variety of asset classes too. As a result, you can use it to measure how well a savings account has been against investments such as bonds or stocks.
Real return is how much an investment makes after taking away other factors from the nominal return. For example, to calculate the real return of an investment, you take the nominal return and deduct any fees, taxes or inflation. It is essentially what you are left with after the cost of investing is taken into account. It is, therefore, a much more accurate number in terms of how much money a savings account has made. Compared to a nominal rate of return, it is even more helpful in comparing returns from different asset classes. However, its drawback is that it is far more complicated and laborious to calculate.
Understanding savings account jargon
So much of the time, picking a savings account is an overwhelming activity due to the complicated language and jargon used. It can make the numbers advertised on different savings products almost meaningless. Potential customers are sometimes unable to make the best decision for them, as their understanding of the market is vague.
Fully understanding some of the language behind savings products can make opening a savings account that much easier. For, we all want to open an account that has the best return. However, we want to do so in relation to our own particular timeline and circumstances - which is where the confusion starts to arise. The issue is worsened by the elitist language used to explain products. By using the above definitions and our subsequent detailed analysis, you will start to improve your knowledge.