Discrete vs. Continuous Compounding

Putting cash in an interest-bearing bank account lets you generate income from savings, but the amount of interest you make depends on more than the interest rate. Interest generated in deposit accounts compounds over time, meaning you start to earn interest on previously earned interest. The amount of time your bank waits before adding accrued interest to your account, known as the compounding period, affects how much interest you earn over time.

Banks use two basic interest compounding methods: periodic and continuous. Under periodic or discrete compounding, accrued interest is added to your account after a fixed amount of time, such as each day, month or year. With continuous compounding, interest is earned on your account continuously, and instantly accrues more interest on the interest. Continuous compounding results in more total interest on your savings over a given amount of time and at a given interest rate because the interest you make starts generating its own interest right away, with no time lapse.