A 2019 study from Bankrate found that 69% of Americans have less than $1,000 in savings. If you find yourself in this category, consider realigning your financial goals to quickly build a rainy day or emergency fund.
When you set up your emergency fund, one of the first things you should do is start storing your extra cash in a high-yield savings account. These accounts earn you more in interest than other saving or checking accounts.
In this article, you’ll learn everything you need to know about high-yield savings accounts so you can determine if they’re a viable option for you.
What is a high-yield savings account?
A high-yield savings account is a bank account with a higher interest rate than traditional savings accounts. In fact, a high-yield savings account can pay up to 25 times the national average for traditional accounts.
High-yield savings accounts have become more readily available over the past few years, thanks to the rise in online banking. Many of the financial institutions offering high-yield accounts do not have brick-and-mortar locations. Because they have less money dedicated to overhead expenses, they can afford to offer you higher interest rates.
But there are also downsides to not having physical locations. For instance, you won’t have access to ATMs directly through your bank. You may also see lag times when completing transfers or mobile check deposits.
One of the most significant factors to consider when weighing a high-yield savings account is how quickly you’ll need access to the funds in the account.
How do high-yield savings accounts work?
To understand high-yield savings accounts, you must first understand how interest works on savings accounts in general.
Interest is what a bank pays you to keep your money in one of its accounts. The amount of interest you receive is based on your interest rate.
It’s called a high-yield savings account because the interest rate is more favorable than a traditional savings account — you are the one yielding a higher interest rate.
The amount of interest you earn on a high-yield savings account is known as the annual percentage yield (APY). APY measures how much money you’ll earn over time.
APY is different from annual percentage rate (APR). APR only factors the interest rate on the account, not how often it compounds. APY considers both the interest rate and how often it compounds.
For instance, let’s say you have $3,000 in an account with a 1.5% interest rate, which compounds annually. At the end of the year, you’ll earn $45.
However, let’s say you put that money in an account which compounds monthly. You’ll earn slightly more money — about a dollar more — and you’ll receive payouts every month.
In this example, the APR is 1.5% — this is the interest rate on the account without factoring how often it compounds. The APY, which accounts for the monthly compounding, is 1.51%.
Your APY will always be higher than APR. Pay attention to APY when comparing savings options.
A high-yield savings account pays you more in interest than a traditional savings or checking account. Rates for high-interest accounts can be up to 20 times higher than the national average and typically range from .75% to 2.5%. This leads to more money in your account, which allows you to move closer to your savings goal.
The benefits of a high-yield savings account
A savings account with the highest rates possible comes with numerous benefits. Let’s take an in-depth look and what you get when you store your money in one of these accounts.
Higher rates than average savings accounts
The most obvious benefit of a high-yield savings account is that you earn more than you would with a traditional account. The higher rate can help you save more money than you would keeping your money in a:
- Traditional savings account
- Checking account
- Credit union
- Money market account
Whether you’re saving for a vacation, emergency or retirement, a high-yield account can allow you to earn more than you would if you kept your money in another account.
Protection of principal and earnings
Your savings rate can fluctuate with each statement cycle. However, you can trust that your principal and previous interest earnings are protected.
If you invest in real estate or the stock market, you risk losing your entire investment. A high-yield account allows you to make money without the risk of losing any.
For example, let’s say you put $1,000 into a high-yield savings account and $1,000 into the stock market. There is no chance that you can lose your deposit into the high-yield savings account, even if your interest rate were to drop to 0%. But if the stock market takes a downturn, you could easily lose your entire $1,000 investment.
Deposit accounts must come with FDIC insurance, which entitles your to $250,000 in protection. This means that, if the bank were to fail, any money that you had in an account, up to $250,000, would be protected.
The insurance extends to each account you have, even if the accounts are held in the same bank. This means that you can receive $250,000 in protection on one checking account and another $250,000 protection on a separate high-yield account.
This offers you protections that you won’t find when investing in the stock market.
The downsides of a high-yield savings account
High-yield accounts may seem too good to be true. Make sure you’re considering the whole picture when deciding whether to store your money there. Below are some of the downsides of high-yield accounts
Savings account rates are tied to the national interest rate set by the Federal Reserve. For instance, some savings accounts were yielding more than 2% in October 2019. Less than a year later, most rates are down to 1%.
Banks can change your savings rate without you being able to do much about it. You can still earn much more than you would in other savings and checking accounts, but the returns may not be as stable as you’d like.
Lack of physical locations
You need to be tech-savvy to use a high-yield savings account. Many national banks offering these accounts do not have physical locations. This means you need to use a mobile app and phone to deposit checks.
Additionally, you won’t have direct access to ATM networks because there are no brick-and-mortar banks. Some high-yield accounts come with an ATM card, granting you access to your funds through other bank’s machines.
Your bank may also be willing to waive ATM fees. This varies from one bank to another, so be sure to do your research if this is important to you.
Lag time when transferring funds
If your high-yield account is with a different institution than your checking account, then you can expect a lag time when you transfer funds between the two.
For instance, with an electronic transfer within your bank’s network, funds are typically available by the next business day. But when transferring from an outside institution, the transaction will likely take 2-4 business days.
If you need access to cash quickly, then a high-yield savings account may not be a good fit.
Eligibility for high-yield accounts
To get your account started, you need to provide basic information, such as your name, address and Social Security number.
Some accounts have a minimum deposit or minimum balance requirements. Others may offer bonuses based on your initial deposit. For instance, you may earn a $500 cash-back bonus if your initial deposit is $25,000 or more.
Because these are cash accounts, your credit score should not impact your eligibility.
You will need to make sure your account balance doesn’t fall below a certain threshold. If it does, your bank may charge monthly service fees. For instance, banks may require you to keep $5,000 at all times. Otherwise, you’ll pay a monthly fee, which may cost more than you earn in interest.
Additionally, you may be charged monthly fees if you make too many withdrawals or if you overdraft your account. Read the fine print when opening the account and determine whether you can commit to the minimum balance requirements and account fees.
If you have money that you’re willing to let grow over time and don’t plan on using your account for day-to-day transactions, then a high-yield account could be an appealing option.
Is a high-yield savings account right for you?
If you are looking to boost your savings, you may want to consider doing so with a high-yield savings account. This is especially the case if you’re savvy with mobile banking and are willing to trust a bank even if you can’t visit its physical location.
High-yield savings accounts won’t yield as much over time as stocks or bonds, but they don’t carry nearly as much risk either. Even during an economic crash, you’ll still have access to the principal and earnings to-date. If you’d like to have cash on hand but don’t plan to use it day-to-day, consider storing it in a high-yield account instead of a traditional savings, checking, or money market account.
Earning high interest rates, setting up automatic transfers and using other savings apps can help you boost your savings.