Pop quiz! Did you know the money you put in savings could be earning more interest? Well, it can! And earning more in interest means you can round out your emergency fund a little faster, or, if you’re debt-free, save for that dream vacation.
A high-yield savings account, also called a high-interest savings account, helps you turn up the heat on meeting your money goals. Now, we’re not talking bonfire heat. Maybe more like Easy-Bake Oven heat. See, a high-yield savings account won’t make you a millionaire overnight, but it will allow you to earn more interest compared to a traditional savings account. Let’s take a look at how high-yield savings accounts work so you can decide if it’s the right type of account for you.
What Is a High-Yield Savings Account?
A higher interest rate sounds bad at first, right? Wrong-ish! Sure, when you’re talking about interest rates that come with debt—you know, car loans, mortgages, credit card payments, that sort of thing—you want to steer clear of a higher interest rate (or avoid one altogether). But when it comes to a savings account, the higher the better!
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With a high-yield savings account, the name says it all. It’s a type of savings account that yields, or earns, a higher rate of interest than a typical savings account.
How a High-Yield Savings Account Works
Here’s the deal with interest rates. They go up and they go down. When you open a savings account, traditional or high-yield, your bank or credit union will quote you their current interest rate. Bank A might offer a different rate than Bank B. But really, they’re pretty much all aiming for the same percentage range, so we’re talking tenths to even hundredths of a percent difference from bank to bank. These days, interest rates for a traditional savings account are around 0.10%. (So don’t start your yacht shopping just yet!)
Unlike traditional savings accounts which you can open at nearly every bank or credit union, high-yield savings accounts aren’t available everywhere. In fact, the best interest rates for high-yield savings accounts are often found through online banks. With lower overhead (no rent to pay, no lobby to furnish, no additional tellers to hire for the drive-thru lane), they can pass those savings onto their customers in the form of better interest rates.
But when we say high-yield, just how high are we talking? Well, if a traditional savings account tends to max out around a tenth of a percent, then a high-yield savings account might take you all the way up to around 1.20% or slightly more. Which, let’s face it, still isn’t all that high. But any bump is better than none. Plus, like with a traditional savings account, in a high-yield account your interest is compounded, meaning the interest you earn on your money can also earn interest.
Let’s take a look at an example. Mary Beth has $1,000 to put into a high-yield savings account at 1.20% annual percentage yield (APY). (Your APY outlines how much interest you can earn in one year if you didn’t add additional money or withdraw funds.) If she doesn’t touch the account for a year, she’ll have earned about $12 in interest by the end of the 12 months. Those same funds in a traditional savings account earning 0.10%? About $1.00.
While $11 might not sound like much more than two lattes, that number keeps growing when you keep making deposits. So, skip the lattes and plan for Christmas instead!
Remember, your interest rate isn’t set in stone for a traditional or high-yield savings account. Your bank can raise or lower your rate at any time. Keep that in mind as you choose a bank. Don’t let a higher interest rate that could easily go down the next day be the only selling point to the bank you choose.
How to Open a High-Yield Savings Account
Do your homework before you open your account. When considering different banks, make sure to ask about any minimum deposit or minimum balance requirements. You don’t want to get hit with any unnecessary fees (banks can be sneaky like this). And don’t forget to ask if there are any ongoing monthly maintenance fees. Avoid those. They could easily eat up all your interest earnings.
Once you’ve picked out your bank or credit union, opening a high-yield savings account is a lot like opening a checking account or traditional savings account. Whether your bank is online or bricks and mortar, be prepared to provide identification, like a passport or driver’s license, plus your Social Security number. Then make a deposit or transfer funds from another account! Easy, right?
Is a High-Yield Savings Account Right for You?
A high-yield savings account is a great place to stash your $1,000 emergency fund (Baby Step 1) or your 3- to 6-month emergency fund (Baby Step 3). That way your money is nearby if you need it but not so close you might accidentally spend it (like if you kept it in your checking account).
This type of savings account isn’t meant to replace your investing accounts long term. The goal is to invest 15% of your income for retirement (Baby Step 4) in accounts where you can earn way higher returns on your investment than in a traditional or high-yield savings account. But if you haven’t met with a financial advisor to determine your best investment options, a high-yield savings account is a good alternative to hold your funds until you’ve selected the accounts to invest in.
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