Let’s take a closer look at what a high-yield savings account is and how it works so you can determine if opening one is the right choice for you.
Definition of a High-Yield Savings Account
A high-yield savings account is a savings vehicle that has a higher interest rate than a traditional savings account. It can be a good option if you’d like to save for a house, car, home improvement project, or another long-term goal. High-yield savings accounts are often offered by online banks that have lower overhead costs. This allows them to pass the savings on to customers in the form of higher interest rates. But traditional banks and credit unions may also offer high-yield savings accounts. Let’s say you deposit $10,000 into a traditional savings account that pays an interest rate of 0.01%. You’ll earn $1 in interest after one year. You’d earn $50 in the same time period if you put the money in a high-yield savings account that pays an interest rate of 0.5% instead.
How a High-Yield Savings Account Works
The specific features of high-yield savings accounts can vary by financial institution. Depending on the account you open, you could see benefits such as no minimum balance requirements, free transfers, no monthly maintenance fees, or online account management and digital banking tools. Other than providing a better rate of interest, high-yield savings accounts can work very similarly to traditional savings accounts. You deposit money and ideally let it grow, but you can access it and withdraw it without penalty, at least to a reasonable extent.
Pros and Cons of High-Yield Savings Accounts
Consider all the advantages and drawbacks before you open a high-yield savings account.
Pros Explained
Earn more interest: A significant benefit of a high-yield savings account is the high interest rate you can earn on the cash you stash. You’ll get more return on your money.Low risk: The FDIC will insure deposits of up to $250,000, including those held in high-yield savings accounts.No additional fees: Many high-yield savings accounts have no monthly fees or minimum balance requirements. But some do charge fees, so it’s important to read the fine print before you commit.
Cons Explained
Fluctuating interest rates: The interest rates on high-yield savings accounts are variable. They can change at any time and are dependent on the economy. Not ideal for long-term wealth: A high-yield savings account can help you with short-term no savings goals, but it’s not ideal for long-term investing. Other accounts such as 401(k)s and IRAs are typically better options for saving for retirement because they come with tax advantages and offer the potential for larger gains. Withdrawal limits: You can access your money in a high-yield savings account, but you’re often limited to a certain amount of withdrawals before you have to pay a fee.
Can You Lose Money in a High-Yield Savings Account?
No investment or savings option is 100% without risk, but high-yield savings accounts definitely fall on the safe side. High-yield accounts are insured by the Federal Deposit Insurance Corporation (FDIC) for deposits up to $250,000. Your money will be insured up to that limit regardless of what’s going on with the economy. But this isn’t to say that the economy can’t have an impact on your money. The FDIC essentially insures against bank collapse, not sinking interest rates. Of course, you won’t lose the money you’ve saved if rates plummet, thanks to the FDIC. But you won’t be earning the interest rate you expected, either.
Key Features To Look For
As with any other financial product, it can pay to compare offerings from various banks and financial institutions because not all high-yield accounts are identical in terms and conditions. Of course, you’ll want to look for the best, highest interest rate, but make sure your access to your money is reasonably unfettered as well.
Alternatives to High-Yield Savings Accounts
Other investment options have the potential to earn even more than high-yield accounts. Consider these alternatives:
Certificates of Deposit (CDs): A CD requires that you tie up your funds for a specific period of time until you reach a maturity date. This can be one year or as long as five years. You get a higher, guaranteed interest rate in return. Individual Retirement Account (IRA): IRAs are designed for retirement savings goals. They come with early withdrawal penalties, but they can help you save more than a high-yield savings account depending on how you invest. An IRA also has tax advantages. 401(k): A 401(k) is an employer-sponsored retirement plan. It allows you to save for retirement with tax advantages, just like an IRA. Employers will often match your 401(k) contributions. You can open a solo 401(k) if you’re an entrepreneur or self-employed. Money Market Account: A money market account is essentially a high-yield savings account that has some of the same features as a checking account. You can access the money you save there with a debit card or a check as often as you’d like.
The Bottom Line
Opening a high-yield savings account is straightforward and similar to the process of opening a checking or traditional savings account. You’ll fill out an application online or via a mobile app in most cases. You’ll provide some basic personal information, including your name and Social Security number, as well as information from your government-issued ID, such as a driver’s license or passport. Most banks and credit unions that offer high-yield savings accounts will perform a soft inquiry into your credit rather than a hard inquiry when you open an account. Your credit score is not affected by a soft inquiry. That’s it. Start depositing your money and saving toward that goal you have in mind.
