What is Discrete Compounding

Discrete compounding refers to the method by which interest is calculated and added to the principal at certain set points in time. For example, interest may be compounded weekly, monthly or even yearly. Discrete compounding is the opposite of continuous compounding, which uses a formula to compute interest as if it were being constantly calculated and added to principal.

BREAKING DOWN Discrete Compounding

The frequency with which interest is compounded has a slight effect on an investor's annual percentage yield (APY). For example, suppose you deposit $100 in an account which earns 5% interest annually. If the bank compounds interest annually, you will have $105 at the end of the year. If, on the other hand, the bank compounds interest daily, you will have $105.13 at the end of the year. Though not technically "continuous" at every second, continuous compounding is considered as such if compounding takes place on a daily basis.

How Does Your Bank Compound Interest?

In the simple illustration above, you can see that less frequent compounding means less interest earnings in your bank account. Even Wells Fargo, which has shown disrespect to millions of its customers by creating fake accounts to dishonestly pile up bank profits, compounds interest daily. The APY, therefore, is higher than yields under discrete compounding that would take place monthly, semi-annually or annually. However, the Wells Fargo customer is not exactly jumping up and down with excitement as of the third quarter of 2020. Interest rates in the economy have been falling, but Wells Fargo's APY in basic checking and savings accounts is even lower at 0.01%. Wells Fargo Way2Save Savings accounts pay 0.01% in interest.  That means if you put $10,000 into the savings account, you would earn a whopping $1.00 in interest for the entire year. Your savings account would have a balance of $10,001. That's not exactly a great way to save, but take solace — you can withdraw that one dollar from the bank and go to Starbucks and buy a half cup of coffee.