What You Should Know About High-Yield Savings Accounts

Suppose your goal is to grow your money without risk. Consider high-yield savings with a much higher annual percentage yield (APY) than regular savings accounts.

What is a high-yield savings account?

A high-yield savings account is a financial instrument that many banks and credit unions offer. You can also open an online high-yield savings account from some digital banks.

However, these accounts offer APYs up to 20 times higher than a traditional savings account. The national average for a savings account is 0.46 percent as of December 2023. Some financial companies have four percent or more in APY for high-yield savings accounts. Additionally, most banks compound interest daily for high-yield savings accounts.

Aside from the APY, high-yield savings accounts work much like standard ones. You open one by filling out an application and making a minimum deposit. The bank pays you interest on the money you deposit. 

You can withdraw your money at will. However, since high-yield savings accounts encourage saving, you may encounter more restrictions on accessing your money. Some may not come with debit cards or place a limit on the number of withdrawals.

A Comparison

The best way to illustrate the difference between a standard and a high-yield savings account is to show you the money. Suppose you open a standard savings account with an initial deposit of $1,000 at an APY of 0.23 percent. You will earn $2.30 in annual interest, assuming you don't put in any more money.

Take a high-yield savings account with the same money at an APY of 3 percent compounded daily. You will earn $30.45 in one year. Suppose you add $50 to the account weekly. Your earnings jump to $69.74.

These are small amounts, but you can see the difference in scale. Investing more in a high-yield savings account can grow your money faster. However, it is not the best option in all cases.

When To Open a High-Yield Savings Account 

Suppose you are saving for a car, vacation, or other big short- or mid-term purchase. A high-yield account makes sense for these goals. It is also appropriate for keeping money safe from impulse spending.

One of the best reasons for a high-yield savings account is to stash emergency funds. You can easily access the money to pay for medical bills or moving expenses. In the meantime, you earn more the longer you keep the money in the account. You should put in any extra money you have every month to grow it even faster.

A high-yield savings account can also help with planned vacations, remodels, and other short-term goals. Aside from the higher yield to your deposit, it provides a dedicated place for the funds you set aside. For example, you are less likely to dip into that when it is separate from your payroll account. It also makes it easier to track.

Big-ticket items like the purchase or downpayment for a car or home take a bit more work. Most people would rely on mortgage companies to acquire these assets. However, a high-yield savings account might help you manage better when saving for a downpayment or making your monthly payments.

When Not To Use a High-Yield Savings Account

Despite the benefits of a high-yield savings account, it is not the best vehicle for all your financial goals. For example, you should not choose it for retirement savings because the interest rates will not match inflation. Choosing a tax-advantaged account like an Individual Retirement Account (IRA) would be better. You can also invest your money in a diversified stock portfolio, yielding more than any deposit account.

Other financial instruments might be more appropriate for some financial goals than a high-yield savings account. Suppose you know you have a balloon payment for your home loan in five years. You can put money in a certificate of deposit (CD) and lock it in for five years. You cannot access the funds until after the term without significant penalties. However, a CD will earn more interest than a savings account.

How To Choose a High-Yield Savings Account

Choosing the best high-yield savings account to open depends on many factors. Consider the following before putting your money in one:

Annual percentage yield (APY)

At its simplest, the APY is the interest the money you put into the account will earn in a year. Most high-yield accounts involve compounded interest, meaning you earn interest on your balance, including interest earned in the previous year. Ensure the financial company where you open the account specifies it in the terms and conditions.

Generally, a higher APY is better because your money will grow faster. However, some banks might impose requirements that will nullify the benefits. For example, you might need to open a checking account when you open a high-yield savings account. In most cases, you must maintain a minimum daily balance for both before you can earn interest. That might tie up more of your funds than you want or can afford.

Fees

Some accounts may carry maintenance and minimum balance fees that eat into any interest you earn. You might avoid these by keeping enough money in the account. However, choosing one that does not have these charges hanging over you would be best.

First deposit

Most banks require you to deposit a minimum amount to open a high-yield savings account, although some do not. Requiring a minimum deposit is not usually a deal breaker since your purpose is to save money. Suppose you are opening an account for the first time and are just starting to earn money. A bank that lets you open an account without putting down any money is an excellent place to start.

Minimum daily balance

Your ability to earn interest from a high-yield savings account might depend on the minimum balance. Some institutions may condition any earnings on your maintaining the minimum amount. Others may offer a tiered APY, increasing the interest rate based on the balance. You must inquire closely about these requirements and conditions to ensure you get the best yield and avoid penalties.

Compounding terms

It is not enough to know that your account earns compounded interest. You should find out if it compounds annually, quarterly, monthly, or daily. The ideal is daily because the more frequently the account compounds, the more you earn.

Insurance

You've probably heard of deposit insurance that protects your money up to a specific amount in case of bank failure. However, you must not assume that all financial institutions have it, especially online banks. Ensure that the companies you are considering have insurance from the appropriate entity. Banks in the US get insurance from the Federal Deposit Insurance Corp. (FDIC). Credit unions deal with the National Credit Union Share Insurance Fund (NCUSIF).

Access

Before April 24, 2020, the Federal Reserve System imposed a limit to the number of withdrawals and transfers for savings deposits. It has lifted Regulation D, so account holders can access their funds as often as possible. However, some banks may impose withdrawal limits per month. It is essential to know your bank's withdrawal when comparison shopping for high-yield savings accounts.

Diversity

A financial institution might be a one-trick pony. They may offer the ideal high-yield savings account but nothing else. That might be inconvenient as you must deal with other banks for other financial services such as mortgages and personal loans. The lack of diversity might also be worrying, as there might be a higher likelihood of failure.

Should you open a high-yield savings account?

Opening a high-yield savings account can ensure your funds are safe and accessible while earning a favorable interest rate. You can use the higher earnings to help achieve short- or long-term goals. However, it is not the best vehicle for all your financial needs. Consider various factors like fees, access, and APY terms before opening one.