How Do High-Yield Savings Accounts Work: A Newcomer’s Guide

Savings accounts are excellent for storing money and earning a little interest on your hard-earned cash. But there’s a lot of emphasis on “little” since the yield or interest you earn in a typical savings account is pretty low (around 0.47%, going by the national average).

Luckily, there are more lucrative ways you might consider for better earnings, like a high-yield savings account. But before you jump into opening one, it’s important to know how high-yield savings accounts work, what their limitations are, and how they can help you reach your money goals.

What’s a high-yield savings account?

A high-yield savings account (or high-interest savings account) is a type of savings account that offers higher interest rates than traditional savings accounts, meaning you’re earning more by leaving your money in that account. Banks, credit unions, and other financial institutions offer these high-yield products to help account holders maximize their savings.

High-yield savings accounts differ from regular savings accounts in how they grow your money over time. While most regular accounts typically use a simple interest model, where you earn interest only on the money you put in the account, high-yield accounts use a compound interest model. With compound interest, you earn interest not only on your deposits but also on the interest you've already earned. It's like money making money on its own, which can help you grow your savings faster.

How do high-yield savings accounts work?

The main purpose of these accounts is to store your money long-term so you can benefit from the compound interest. If you leave your money in the account, it grows more, and if you withdraw money, you’ll reduce your interest-earning potential.

The amount of interest you can earn through these accounts depends on the annual percentage yield (APY) your bank sets. An APY is the rate at which your account can earn interest over the course of a year, so a higher APY means you’ll earn more interest.

These rates are also variable, meaning the one you get when you sign up for the account won’t be your APY forever. Instead, banks change these rates when economic conditions change. For instance, if the Federal Reserve raises interest rates, APYs increase; if they lower them, APYs decrease. Plus, many financial institutions offer promotions where you see a higher APY for an introductory period.

If you’re looking to open a high-yield savings account, the process is pretty straightforward. All it takes to get the ball rolling is filling out an application, which you can complete online or in person at a bank. You’ll usually have to provide your income, employment information, and other financial and personal details. Once the bank approves your application and opens your account, you can deposit your funds and start earning interest.

Pros and cons of high-yield savings accounts

While these accounts offer many benefits for growing your money, they also have some potential downsides that could impact your financial situation. Here are some of the pros and cons to consider as you look for the best high-yield savings for your situation:

Pros

- Earning potential: With higher interest rates plus compound interest, you stand to grow your money a lot faster in a high-yield savings account versus a traditional account. Compounding interest builds on what you earn, plus principal.

- Security: Savings accounts from banks or credit unions are insured by government-funded organizations. While the Federal Deposit Insurance Corporation (FDIC) insures most banks, the National Credit Union Association (NCUA) insures credit unions. If you have an account with a bank or credit union and they lose your funds, these insurance providers will reimburse you up to $250,000 per account.

- Digital platforms: Most institutions that offer high-yield savings accounts have convenient online platforms and mobile apps that allow you to bank whenever you need, 24/7, from any Wi-Fi-enabled device you choose.

- Easy money transfers: Most accounts make it easy to transfer money when you need to, whether you need to move money into another account or add funds to your high-yield account.

Cons

- Limited physical locations for banking: While many high-yield providers have great online offerings, they often lack physical banking locations. This can be a drawback if you prefer in-person banking.

- Fluctuating interest rates: Since high-yield interest rates are variable, there’s no guarantee your interest rate won’t drop down the line.

- Limited withdrawal options: It’s not common for banks to provide ATM or debit cards for high-yield savings accounts. This means you’ll have to make most withdrawals online or in person (if the bank has a physical location).

- Economic changes impact savings: Inflation ultimately devalues cash savings, including in high-yield accounts.

What to look for in high-yield savings accounts

Not all high-yield savings accounts offer the same benefits or perks. Before you settle on a financial provider to open an account with, consider these variables:

- Initial interest rate offering: Double-check the APY interest rate you’ll receive when you sign-up. Some initial rates are purely promotional and not the standard APY. You want to make sure you’re getting a competitive rate around the standard APY and not losing out on valuable percentage points down the line.

- Compounding terms: How often your interest compounds can affect how much money you earn. For example, if the interest compounds quarterly, that’s only four times a year your bank is adding more money to your account for you to earn more interest on. If the interest compounds monthly, that’s 12 times a year you’re receiving money that you can earn interest on. Accounts that offer a more frequent compounding schedule can lead to more interest earnings.

- Cross-account compatibility: Make sure the savings account is compatible with other banks or brokerage accounts, especially if you have other accounts, like checking or money market accounts. If not, you may have difficulty moving your money.

- Minimum balance requirements: Most of these accounts require a minimum balance. Some may be as low as $25, while others may be as high as $25,000. Determine how much you plan on putting in the account initially, and don’t sign up for any that ask for more than that number.

- Fees: Most financial institutions implement some sort of fee structure, especially for overdrafts (taking out more money than your account holds) and frequent withdrawals. Some banks also charge service and administration fees, which they deduct directly from account balances. Before you agree to any account, you’ll need to know any potential fees you’ll encounter so you don’t face surprise charges later on.

When to open a high-yield savings account

Opening a high-yield savings account can be a great financial move, but it’s a personal decision, too. Here are some situations where you might benefit from opening a high-yield savings account:

- Saving for a short-term goal: While long-term goals may benefit from more high-risk, high-reward investments, short-term goals require a safer approach to make sure you don’t lose a serious amount of money. Putting your money in a high-interest account can help you reach your goals sooner with peace of mind in the process.

- Building an emergency fund: If you need to build an emergency fund, putting money in a high-yield savings account and letting it accrue interest can help you build it quicker than you might with a regular savings or checking account.

- Looking for low-risk investment opportunities: There are a lot of different investment opportunities out there, but risk can play a big factor in what type you feel most comfortable with. If you’re not ready to put your money in a situation where you can easily lose, like stocks, having a high-yield savings account can give you some significant earnings while you take a more conservative approach with your hard-earned money.

- Not earning enough value from traditional savings: If you have money in a traditional savings account that you don’t plan on withdrawing from frequently and want to earn higher interest, this could be the perfect move for your money.

FAQs

Q: Are high-yield savings accounts safe?

A: The safest accounts are those backed by government-funded insurance providers, like the FDIC or NCUA. This insurance provides protection for deposits up to the maximum limit allowed by law (currently $250,000 per depositor, per insured bank). FDIC insurance ensures that if the bank were to fail, depositors would receive their funds back up to the insured limit.

Q: How often do high-yield savings accounts pay interest?

A: How often you earn interest on these accounts depends entirely on the terms set by the banking institution. Some accounts have more frequent payout schedules, like monthly payments, while others may operate on a semi-annual or annual schedule.

Q: Can I withdraw money from a high-yield savings account?

A: Yes, you can withdraw money from a high-yield account, but your bank may have some restrictions on how much or how often you can withdraw, depending on the terms of your account. Since some accounts have a minimum balance requirement, you usually can’t withdraw below this threshold without facing fees. Other accounts may limit you to a few withdrawals over a period of time, like six a month.

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