Have you ever checked how much interest you’re earning on the money in your bank account? If you did, you’d probably be shocked — and not in a good way.
That’s because, when it comes to traditional savings accounts, you’re hardly earning any interest at all. The national average annual percentage yield, according to the Federal Deposit Insurance Corporation (FDIC), is just 0.09%.
Translation: If you had $1,000 in savings, you’d earn a measly 90 cents in interest over the course of an entire year. (And you would still need a couch-cushion dime to order off the dollar menu!)
Lately, however, that’s changing. More and more banks have introduced “high-yield savings accounts” that feature exponentially better rates.
Here’s what you need to know about these newfangled accounts, plus how to find the right one for you.
What Is a High-Yield Savings Account?
High-yield savings accounts are similar to traditional savings accounts, with one major difference: They offer a much higher annual percentage yield (APY).
Your account’s APY differs from its interest rate because it also considers the frequency of compounding (when you earn interest on your interest). Most savings accounts compound daily or monthly.
Simply put, APY is what you’ll earn each year: A $100 account with 1% APY, for instance, would close out the year with $101. The higher the APY, the more money you’ll earn.
Whereas most traditional savings accounts have APYs of less than a tenth of a percent, the new cadre of high-yield savings accounts offer APYs of 2% or more — a 20-fold increase.
It’s important to note that APYs aren’t fixed. So even if you sign up for a savings account touting a 2.5% APY today, it could drop tomorrow. This is why you should monitor your statements carefully to stay on top of APY fluctuations.
Why You Should Care About High-Yield Savings Accounts
Although it might sound like just a few percentage points, a slightly higher APY can make a big difference over time.
Let’s say you’ve managed to set aside $10,000 for your emergency fund (#nailedit). Since you want the money to be easily accessible, you’ve decided to keep it in a savings account.
Here’s the problem: You’re not sure which type of savings account you should put your cash into. A traditional account at your old-school bank? Or a high-yield account at an online-only upstart?
Let’s take a look at the numbers.
If your interest compounded daily for 10 years, here’s how much you’d accrue:
- Traditional Savings Account (0.09% APY) = $90
- High-yield Savings Account (1.6% APY) = $11,720
How Do High-Yield Savings Accounts Work?
High-yield savings accounts work just like traditional savings accounts: You deposit money, earn interest, then withdraw the money when you need it.
Due to federal regulations, you can only withdraw money up to six times per month — but that’s true for all types of savings accounts.
When you sign up for a high-yield savings account, the only real differences in your experience will be A) a higher APY, and B) a lack of physical branches. You’ll find most high-yield savings accounts at online-only banks, which have less overhead and can pass along the savings to you.
High-Yield Savings vs. CDs
When you put money into a high-yield savings account, you can withdraw it whenever you’d like.
But when you put money into a certificate of deposit (CD), you’re committing to keeping it there for a certain amount of time — somewhere between several months and five years. If you need to withdraw the money early, you’ll likely have to pay a penalty.
In the past, CDs had exponentially higher APYs than savings accounts — which was what made them attractive. When compared to high-yield savings accounts, however, CDs aren’t all that impressive.
So, unless you’re positive you won’t need your money for a while (or are looking for a reason to lock it up), we’d recommend high-yield savings accounts instead.
High-Yield Savings vs. Money Market Funds & Accounts
Rather than simply earning interest from your bank, money market funds and accounts invest in highly-liquid, low-risk instruments such as CDs and U.S. Treasuries.
- Money market accounts generally come with slightly higher returns than high-yield savings accounts, and, like most savings accounts, are insured by the FDIC for up to $250,000.
- Money market funds are slightly riskier, with a potential for higher returns — and are not backed by the FDIC.
Though money market funds have historically generated higher returns (more risk = more reward), Lawrence Solomon, a certified financial planner with Mercer Advisors, says that’s not been the case of late.
“Ironically, right now you can actually get better yields on savings and money market accounts than you can with money market funds,” says Solomon.
How to Use High-Yield Savings Accounts
According to Peter M. Ferriello, a certified financial planner with Mollot & Hardy, Inc. Wealth Advisors, high-yield savings accounts are best “for those looking to keep funds in cash, possibly for use as their emergency fund, as they will receive a higher rate of return than they would in their checking account.”
To create your emergency fund, set up an automatic transfer from your checking account. Every week, two weeks, or month, transfer a set amount until you’ve amassed enough money to cover three to six months of expenses.
Then, start funneling any additional savings — for retirement, your children’s education, etc. — into investment accounts that earn a higher return. Don’t be like the average millennial, who holds 65% of their assets in cash (ie: savings accounts), and is missing out on significant returns in the long-run.
“The real rate of return on cash has not kept pace with the long-term rate of inflation,” says Solomon.
So, for long-term goals, he recommends investing in the market, where you can “grow your money faster than inflation is shrinking it.”
How to Choose a High-Yield Savings Account
Although choosing a high-yield savings account isn’t much different than choosing any other bank account, here are three things to keep an eye out for:
- Balance or spend requirements: Some banks require you to open your account with a certain balance, maintain a minimum monthly balance, set up direct deposit, or spend a certain amount each month. Before signing up, make sure you can meet these requirements. Better yet, look for a bank account that doesn’t have any requirements – like Chime!
- Fees: To help them account for their increased APYs, some banks with high-yield savings accounts charge monthly maintenance fees. Since fees of any kind are lame, we always recommend looking for a fee-free bank.
- Insurance: Your chosen bank should be backed by the FDIC. (Some high-yield savings accounts have come under fire for not being FDIC-insured.)
If you’re not sure which to choose, just listen to Riley Poppy, a certified financial planner with Ignite Financial Planning: “I tell my clients to follow four basic rules when choosing an account: safe, liquid, free, and competitive yield.”