How compound interest works with high-interest savings accounts

Compound interest grows upon itself. Think of it as the “snowball effect.” When a snowball rolls down a hill, it continuously picks up snow – the bigger the snowball gets, the more snow it packs on – it compounds during its travel down the hill.

A high-yield interest account can be looked at in the same way.

Interest is earned on money that previously earned interest. This cycle leads to increasing interest as balances get bigger and bigger.

High-interest savings accounts make you money

Compound interest is the key to how high-interest savings accounts make you money. Currently, the average annual percentage yield across all savings accounts is just 0.43% APY, according to the Federal Deposit Insurance Corp with some big banks, Chase, paying as low as 0.01%.

High-interest savings accounts currently earn around 16 times more than the national rate. That makes a big difference in what 0.43 percent will make you. For example:

• Deposit $10,000 in a savings account that earns compound interest at 0.43% APY. Assuming interest compounds on a monthly basis, in one year you'll have made $42.00.

• Deposit $10,000 in a savings account that earns compound interest at 5.00% APY. Assuming interest compounds on a monthly basis, in one year you'll have made $511.

If you’re not earning that “interest-on-interest” (compound interest) in a high-yield savings account, you’re leaving money on the table.

How much high-interest savings accounts earn

Example: Check out how much an initial deposit of $1,000 with $100 monthly deposits will earn over 20 years with a 5.00% APY.

The figure above breaks down how much different savings accounts can yield using an initial deposit of $1,000 into an account with a 5.00% APY, plus adding $100 every month and never incurring any fees.

If you keep saving for 20 years, you'll have approximately $43,816 in your account (total contributions: $25,000) and you'll have made $18,816 in interest. That's a nice chunk of money earned in interest.

Restrictions on savings accounts

While savings accounts are the most reliable and safe investments, they do have a few restrictions. Many high-yield savings accounts have minimum balance requirements and penalize you with fees or lower APYs if you don't maintain that level of investment.

Plus, due to a Federal Reserve Board rule known as Regulation D, account holders are only allowed to withdraw or transfer money six times per month without paying a penalty.

Regulation D limits the number of certain types of withdrawals or transfers that can be made from savings accounts or money market accounts.

Under Regulation D, savings accounts and money market accounts are considered “non-transaction accounts,” which means that they are intended for saving money rather than frequent transactions. As such, the regulation limits the number of certain types of transactions that can be made from these accounts to no more than six per statement cycle.

The types of transactions that are subject to the limit include:

• Transfers or withdrawals made by preauthorized or automatic transfer, or by telephone, fax, or online transfer.
• Transfers or withdrawals made by check, draft, debit card, or similar order made by the account holder and payable to third parties.
• Transfers or withdrawals made by overdraft transfer or withdrawal.

If an account holder exceeds the limit of six transactions in a statement cycle, the financial institution may charge a fee or convert the account to a checking account, which is not subject to the same transaction limits.

It's important to note that the six-transaction limit only applies to certain types of transactions and does not limit other types of account activity, such as deposits, ATM withdrawals, or in-person transactions at a bank branch.

The purpose of Regulation D is to encourage consumers to use savings accounts for their intended purpose of saving money, rather than as a transaction account. Additionally, the regulation helps banks manage their reserve requirements, which are the funds that banks are required to hold in reserve to cover potential losses. By limiting the number of transactions from savings accounts, banks are better able to manage their reserve requirements and ensure their financial stability.

Benefits of a Savings Account

Having a savings account can provide several benefits, including:

Emergency fund: A savings account can provide a safe place to save money for unexpected expenses or emergencies. Having an emergency fund can provide peace of mind and help you avoid high-interest debt when unexpected expenses arise. Check out these saving money tips to help make building an emergency fund simple.

Earn interest: Savings accounts pay interest on the money deposited, which can help your savings grow over time. Earning interest on your money is one of the main benefits of having a savings account.

Easy access to cash: Unlike a certificate of deposit (CD) or other long-term investment, money in a savings account is generally easily accessible when you need it. This can be helpful for short-term savings goals, such as saving for a vacation or a down payment on a house.

Low risk: Savings accounts are typically considered low-risk investments because they are FDIC-insured, which means that your money is protected up to a certain amount if the bank fails.

Goal-oriented savings: A savings account can help you stay motivated to save for a specific goal. You can set up automatic transfers to your savings account to make saving easier and more consistent.

No ATM Card. Some savings accounts don’t offer an ATM card. But if your goal is to build wealth and earn as much compound interest as possible, you don't want to make too many withdrawals anyway.

Overall, a savings account can provide a safe and convenient way to save money and help you reach your financial goals. Learn about No-ChexSystems Banks if you are unable to open a savings account.

Saving vs Investing

Saving and investing are two different approaches to managing your money, and both can play an important role in achieving your financial goals.

Saving money is the act of setting aside money for short-term needs or emergencies. Saving typically involves putting your money into a low-risk savings account, money market account, or certificate of deposit. Savings accounts offer little or no risk, and typically pay low interest rates, but the money is easily accessible when needed.

Investing, on the other hand, involves putting your money into assets such as stocks, bonds, mutual funds, real estate, or other investments with the goal of earning a return over the long-term. Investing typically involves more risk than saving, but also offers the potential for higher returns. Investments can be used to build wealth over time, achieve long-term financial goals such as retirement, or generate passive income.

Both a savings and investing accounts are generally taxable. But here are some key differences between saving and investing

Risk: Saving is generally considered low-risk, with minimal potential for loss, while investing carries more risk, with the potential for significant gains or losses

Returns: Saving typically offers low returns, while investing can offer higher returns over the long-term.

Liquidity: Savings accounts are generally easily accessible and liquid, while investments may be harder to sell or access quickly.

Time horizon: Saving is typically geared toward short-term goals, while investing is geared toward long-term goals.

Diversification: Investing can involve diversifying your assets to spread out risk, while saving usually involves keeping money in a savings account or CD.

Investing can be complicated but it's also one of the quickest and most effective ways to make your money grow. If you're new to investing take a little time to learn how to research and evaluate potential stock purchases, dividends, mutual funds, exchange-traded funds (ETFs) and other investment vehicles.

You can invest on your own but it's probably best to start with a broker. But remember that brokerage firms charge different amounts to use their services, and the fees may vary by how much you have in your accounts. Fees can eat up a big chunk of your savings, so be sure you shop around to find the fee schedule that costs you the least before high-risk investing.

It's important to keep in mind the risks that come with investing in stocks. Many people saw their investing portfolios lose half their value or more during the Great Recession, but those who held on saw their investments recover and then some within a few years.

Few investments come without risk unless it's a high-yield savings account. The ones with the greatest risk stand to bring the greatest gains, but also the greatest loses.