Understanding Interest Rates: Is 12% Annually the Same as 1% Monthly?

Many people have trouble understanding interest rates and how to calculate them, which can lead to an incorrect interpretation of financial information. Fortunately, TC Financial Calculators can make rate calculations simple. The Financial Calculators in Truth Concepts include Future Value, Present Value, Interest Rate, Payment, and Time Period. You'll find them in the toolbar by clicking Calculators, then hovering over Financial in the drop-down menu. For this particular example, let's answer the question: How do you calculate if 12% annually is the same as 1% monthly?

Step 1: Grab the Correct Calculator

The Financial Calculators are relatively simple calculators that all center around the same five variables (for which the calculators get their names). The difference between the calculators is how those variables relate to each other. You'll know which calculator to choose based on which variable you want to solve for.

While you may be inclined to pull up the Rate Calculator first, we're actually going to start with the Future Value Calculator. That's because we're going to start our calculation by determining the future account value of an account earning an annual 12%.

Step 2: Find the Future Value of an Annual Rate

To start the comparison, pull up your first Future Value calculator and set the Present Value to $100,000, and the interest rate to 12%. In order to make sure that we're calculating the time period in years, be sure to check the box marked “A” on the bottom right of the calculator. Finally, set the time period to 1 year.

Once you've done this, you'll see that 12% applied annually makes the account go from $100,000 to $112,000.

Understanding interest rates with a future value calculator. This calculator is showing what a 12% interest rate applied annually would do to $100,000.

Step 3: Find the Future Value of a Monthly Rate

Now, let's grab another Future Value Calculator. You can do this quickly by hitting the button that says “New” on the right-hand side of the first Future Value calculator. This time, make sure you click the “M” for “Monthly” to have the time frame be calculated in months. All other variables will remain the same, so the Present Value is $100,000, the interest rate is 12%, and the time frame is 12 months.

This time, the result is $112,683.

Understanding interest rates using a future value calculator. This calculator shows what a 12% annual rate would do to $100,000 if applied over 12 months.

Analyzing the Interest Rates

Remember that no variables were changed here. The only difference is that instead of calculating the annual interest rate as being applied annually, we calculated it as if it were applied monthly. In other words, the account was compounding. So while it may mathematically work out to 1% a month, the result is not equivalent.

Most banks compound monthly, and a few savings and loan rates compound quarterly, yet it is common to express interest rates in annual terms so it gets confusing. There are hard money investments or bridge loans that express their payment in monthly terms, like 1% a month.

While the difference in this example is small, this critical distinction shows the true power of compounding interest. Earning a compounding 1% monthly can make a larger impact than 12% applied annually. While you may not get to choose these terms yourself, it certainly demonstrates the power of leaving accounts to compound uninterrupted.

For more lessons on how to use Truth Concepts financial calculators in your practice, remember to sign up for Truth Training. Our 3-day event gives you an in-depth dive into the whole calculator suite and how to tell your stories accurately with numbers.

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