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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 0.06%.
Translation: If you had $1,000 in savings, you’d earn a measly 60 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.
But how do high-yield savings accounts work? Here’s a closer look at how you can use a high-yield account to grow your money.
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What Is a High-Yield Savings Account?
A high-yield savings account is a savings account that pays a higher annual percentage yield or APY than other types of savings accounts. That’s a simple high-yield savings account definition but there’s a little more to it, in terms of how interest works on a savings account.
The APY on a savings account isn’t the same as the interest rate. That’s because APY considers how often interest compounds. Most savings accounts compound interest daily or monthly. The APY reflects what you’ll earn interest each year.
So if you put $100 into a savings account with a 1% APY and don’t make any other deposits, you’d end the year with $101. The higher the APY and the more deposits you make, the more interest you’ll earn.
What is the average interest rate on a savings account? As mentioned, the national average is 0.06%, as of the Fed’s January 2022 rate update. High-yield savings accounts, by comparison, can offer an APY that’s eight, 10, 15 or even 20 times higher than the national average.
The APY on a high-yield savings account or any other type of savings account can change over time. That’s because savings account rates are influenced by, though not directly tied to, changes in the federal funds rate. This is the interest rate at which banks lend money to one another. If the Federal Reserve raises rates, then banks typically follow suit and offer better rates to savers. But if the Fed initiates a rate cut, then banks might reduce rates which is when it pays to have a high-yield savings account.
How Do High-Yield Savings Accounts Work?
High-yield savings accounts work by allowing you to deposit money and earn interest on the balance. You can withdraw money as needed, though you might be limited as to how often. The Federal Reserve suspended Regulation D in 2020, which limited savers to six withdrawals per month but banks can still impose withdrawal limits.
In that sense, high-yield savings accounts aren’t that different from other types of savings accounts. But there is a difference in where you might open one of these accounts. It’s more common to find high-yield savings accounts offered through online banks or non-bank fintech companies. The reason? Online banks tend to have lower overhead costs than brick-and-mortar banks so they can pass along added savings to customers in the form of higher interest rates.
But high-yield savings accounts aren’t all alike when it comes to the rates they pay, minimum deposit or minimum balance requirements and fees. So which savings account will earn you the most money? The simple answer is the account that offers the best combination of rates, fees and terms, based on your needs.
How to Use High-Yield Savings Accounts
High-yield savings accounts can be used to meet short or long-term savings goals. 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.”
So what is a high-yield savings account good for? You can use these accounts to save for:
- Financial emergencies
- A down payment on a home
- Purchase of a new car
- A dream vacation
- Wedding expenses
- Starting a side hustle or business
- Home repairs or renovations
- Just about anything else you might need money for
But how do you get the most out of your high-yield savings account?
The first step is choosing the right high-interest savings account to open. Again, that means looking at different banks to see who pays the best APY for high-yield savings, how much you’ll need to deposit, what you might pay in fees and how you’ll be able to access your money.
You can also maximize a high-yield savings account by automating your savings efforts. So, to create your emergency fund you could set up an automatic transfer from your checking account. Every payday, you can transfer a set amount of money until you’ve reached your goal of saving three to six months of expenses.
Another way to grow your high-yield savings is to use windfalls to boost your balance. For example, you might decide to stash your tax refund or stimulus check in savings along with rebates, refunds or cash gifts you receive for birthdays or special occasions.
Should you use a high-yield savings account to save for retirement or higher education? Not so fast, says Lawrence Solomon, a certified financial planner with Mercer Advisors. Keeping the majority of your money in savings instead of investing it in the market could cause you to miss 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.”
High-Yield Savings Account Pros and Cons
High-yield savings accounts have some attractive features but they aren’t necessarily right for every saver. Here are some of the pros and cons to be aware of before opening one of these accounts.
High-yield savings account pros:
- Earn a higher interest rate and APY than you would with a traditional savings account
- High-yield savings accounts offered by online banks tend to have fewer fees
- Initial deposit and minimum balance requirements may be lower for high-yield accounts
- A high-yield savings account at an FDIC-insured bank is safe and protected in the very rare chance that the bank fails
- High-yield savings accounts can offer convenient access to your money through mobile banking and ACH transfers to a linked bank account
High-yield savings account cons:
- Interest rates are not set in stone and can fluctuate over time, moving higher or lower
- The APY you earn with a high-yield account may not be enough to keep pace with the rate of inflation
- Investing your money in the market could yield a higher rate of return
- Transfers to an external bank account can take a few days to process
- Making more than six withdrawals from your savings account each month could trigger an excess withdrawal fee
High-Yield Savings vs. CDs
A high-yield savings account is one way to save; a certificate of deposit (CD) is another. A CD is a time deposit account, meaning you agree to leave your money in the account for a set time period. Meanwhile, your savings earns interest and once the CD matures, you can withdraw your initial deposit and the interest earned. Depending on the CD, the term may last anywhere from 30 days to 10 years.
CDs can sometimes offer higher APYs than high-yield savings accounts, but you might be required to make a larger minimum deposit. For instance, some high-interest savings accounts set the minimum deposit at just $1 but you might need $500 or $1,000 to open a CD. And higher rates aren’t always guaranteed.
Aside from that, you have limited access to the money in a CD. If you need to withdraw money before a CD matures, you’ll likely have to pay an early withdrawal penalty. This penalty can be equivalent to some or all of the interest earned. 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
A money market account or money market fund is another possibility for saving. 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), Solomon 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.
Money market accounts can also offer some other advantages over high-yield savings. Depending on the account you might be able to get a debit card or have check-writing abilities. That could make it easier to access your money, as high-yield savings accounts typically don’t include these features.
How does interest work on a savings account?
Interest accrues on a savings account at the rate set by the bank. This interest can compound daily or monthly, with interest earned typically paid out on a monthly basis. The interest rate on a savings account is not the same as the APY, which reflects the amount of interest you could earn from the account over the course of a year.
What is the average interest rate on a savings account?
As of January 2022, the national average interest rate for a savings account was 0.06%4, according to the Federal Reserve. The rates for high-yield savings accounts tend to be much higher.
What is the high yield savings account definition?
A high-yield savings account is a savings account that offers a higher yield and interest rate than other types of savings accounts. High-yield savings accounts are most commonly found at online banks rather than traditional banks.
Which savings account will earn you the most money?
A savings account that offers a higher APY and a higher interest rate will earn you the most money over time. Generally speaking, high-yield savings accounts can make it easier to grow your money than traditional savings accounts.