High Yield Savings Accounts 101: How to Earn Compound Interest

Most likely, if you have followed any finance industry news your lifetime, you have probably heard the familiar term “high yield savings account.” Many banks have been aggressively pushing these types of savings accounts for many years.

For many people, it seems like a much better alternative compared to investing in the stock market. Some people may even find that a high yield savings account can be a wiser decision than buying bonds as an investment.

After all, with a savings account, you do not have to worry about it potentially crashing after a few weeks to losing all your income. High yield savings accounts are typically touted as a safe low risk investment by most banks. They also promise high returns and tax benefits. You won’t have nearly the stress you would as if you were investing in volatile penny stocks!

But are high yield savings accounts really worth it? Can they live up to all the hype? That’s what we have to figure out, and like almost every single type of investment, one size does not fit all. It often depends on each person’s individual and unique financial situation.

And, you may even be asking: what does a high yield savings account mean? How is it different from other types of savings accounts?

Today, we’ll take a look at what high yield savings accounts really are, what the term “high yield” actually means and where you can find them if you decide to invest in one.

What is a high yield savings account?

Chances are, you already likely know what a savings account is.

A savings account is a type of account at a bank where you deposit an amount of money to keep it there for typically a relatively small period of time – maybe a year or two. In most cases, most banks do not pay a lot of interest on your money they hold for you.

This is unfortunate, because they certainly don’t just keep that money sitting around collecting dust! The bank uses your money for their own investments to make money, and so using a basic simple savings account is one of the worst ways to save or make money!

So, enter the high yield savings account. A high yield savings account is simply a savings account  which offers you competitive interest rates. Banks want your money, because that gives them more money to use for their own investments, and so they are willing to pay you interest based on the amount of money you deposit into your account.

In most cases, banks will offer you perks for opening a high yield savings account. They will often tout as having competitive rates, which basically only means they’ll pay you around the same amount of interest as other banks would.

Among the perk of opening a high yield savings account is the offer of a higher APY, or Annual Percentage Yield. However, you may not always consider the amount they offer as being high! I would consider “high” to be 20% or more, but you’d be very hard pressed to find a bank that actually offers that type of return on a savings account!

Understanding the Requirements to Open a High Yield Bank Account

Typically, banks require a very large deposit sum in order to open up a high yield bank account. There may also be account minimums and term limits – for example, you cannot make a withdraw amount that would cause the account to go beyond the minimum requirement, or you may be limited by how many withdrawals you can make out of the account in a single calendar year.

It’s important to understand that not everyone is eligible to open these types of accounts. You don’t have to be dazzling special, but you do need to be prepared to be able to put your money where your mouth is!

Here is what most banks typically require when you open up a high yield savings account:

A Large Initial Deposit: Most banks will have minimums for the amount of the initial deposit. Some banks can require $10,000 or more in order for you to qualify for the best rates. Often times the larger the initial deposit amount is, the better rates the bank will offer, but this is not always the case. Online banks may have lower initial deposit amounts.

Account Limits: Most of the time, you will be severely limited by what type of activity you can do on these accounts. You can put in $20,000, but that doesn’t mean you can just waltz in next Friday and ask to take out $10,000. Your bank may limit how many transactions you can do each month or quarter, and they may also require you keep a minimum balance in the account.

Have Other Assets, Accounts & Transactions: Your account history at the bank may also be a factor. Some banks will require you also keep a regular checking account or other type of account with them in order to activate your high-yield savings account. Some banks may even only allow established customers with certain assets to even be eligible to open a high yield savings account.

While the requirements are a lot for some people to be expected to meet, for many people it is a wise decision. After all, it is better to have money earning interest than doing nothing! This is wise if you are saving up for a larger investment in the future, such as buying property or saving for your children’s college education expenses.

How to Open a High Yield Savings Account

So, let’s say you decide you want to open up a high yield savings account.  Where do you go?

Fortunately, today you have a lot of options. With internet banking continuing to raise in popularity, you can find a lot of offers available to explore. There are a lot of options, and you can find many perks to online banks.

Since online banks do not have the traditional overhead as your local bank office near your home, you will find they can often offer better interest rates and do not have quite as high initial deposit amounts.

The biggest downside to online banking of course is if you have questions or need to get money quickly, you will have to wait for the transactions to post and process. Typically you will also need to link your online bank account to a traditional checking account to ensure there is a way for the bank to make withdrawals and deposits.

You may also need to factor in transaction costs – some banks will charge a processing fee if you need to transfer money to a different account. Online savings accounts also typically are not as easy to access the funds – it is not like you will have an ATM card or be able to write a check to get the money.

Your local bank that you already have an account with is another option. They may be able to at the very least discuss the different options they have available to you and make recommendations for what might be the best solution for your finances based on your banking history with them.

How Much Money Can I Make With a High Yield Savings Account?

Ah, yes, this is the magic question, isn’t it now? The answer truly depends on how much you start with an as initial deposit, whether you continue to deposit money into the account, and what the annual interest rate might be.

For example, if you start with $10,000 and have an annual interest rate compounded at 6.5% a year, in 10 years you’ll have $19,121.84.

That’s about $9,000 doing absolutely nothing – Nice!

But, let’s say you decide to invest $100 into the account each month in addition to the initial $10,000. Over the course of 10 years, you’ll be saving up $100 per month, or $1,200 per year. In 10 years, you will have deposited a total of $12,000.

This means you have the initial $10,000, plus the $12,000 you deposited over 10 years – and of course the compounded interest rate. Doing it this way, you’d have $35,962.15 at the end of 10 years. In this instance, you will have earned $13,962.12 in interest.

Bottom Line: The more you save, the more you earn.

Most of the times the interest in a high yield savings account is compounding interest, which means you eventually begin to earn interest on the interest you’ve earned. You may remember learning about compound interest in math class in school. I know I still have memories about my algebra teacher making us learn about compounding interest when I was in the 8th grade!

At any rate, what you put in will greatly influence how much you can get out of the account. It is best to start with a high initial deposit of at least $10,000, but the more you can invest the better return you will see. This is why even if you only deposit a small amount each month consistently this can help your savings grow quite considerably.

Of course, you still should keep in mind things such as inflation and whether this investment makes sound sense for you. If you are deep in debt for example, it would likely be better to pay off all of your debts first and then work towards opening up and saving in a high yield savings account, because the amount you make in a savings account is not going to be more than what the interest rate on debt loans or credit cards might be.

Do you have a high yield savings account? What banks do you recommend for opening up a high yield savings account with? Do you have any tips for someone who is exploring whether or not they should open up a high yield savings account? Share your thoughts in the comments section below!