Personal Finance 101: High Yield Savings Accounts

What Is a High Yield Savings Account?
•    High yield savings accounts offer dramatically higher interest rates than traditional savings accounts.
•    High yield savings accounts are FDIC insured, just like traditional savings accounts.
•    Consumers choose high yield savings accounts when they want security, ready access to cash, and a meaningful return.

Let’s say you’re saving for a big expense—such as a new car, a vacation, or a wedding. You’re planning to sock away a few hundred dollars every month, and it would be nice if your money could earn something better than the low interest rate your traditional savings account offers. 

You could invest the money in stocks, but there’s always the risk of losing principal. You could  buy a certificate of deposit, which offers safety and a higher interest rate, but may leave you without easy access to your money should an emergency arise. 

High yield savings accounts can offer a solution. To understand why, it helps to know a few things about savings accounts in general. 

What Is a Savings Account?
When you open a savings account, you deposit an amount of money with a bank. The bank keeps your money safe as you continue to make deposits and withdrawals. Because the money in your savings account helps the bank fund loans, you earn money back as interest. 

Without knowing how often accrued interest is compounded—added to the original balance from which the interest is calculated—you can’t know how much your account will earn at the end of the year. 

Annual percentage yield gives you that information, because it takes compounding into account. 

To appreciate why the APY is important, it helps to understand how compound interest works:
•    Compounding happens when the interest your savings has accrued is added to your account balance. 
•    The next time interest is calculated, it is based on this new balance—and so on, every time interest is compounded.
•    Interest can be compounded daily, weekly, monthly, semi-annually, or annually, depending on the institution.
•    More frequent compounding translates to a higher yield over time.

The interest rate of a given savings account is determined by many factors, including the discretion of the bank. In general, rates on savings accounts rise and fall with the interest rates of mortgages, credit cards, and other loans. These rates all move in response to the federal funds rate, which is set by the Federal Reserve, the U.S. central bank.

Benefits of a High Yield Account
A high yield savings account is distinguished from a traditional savings account by its interest rate. Today, the average APY for traditional savings accounts at large banks is 0.1%. Many high yield savings accounts, however, offer APYs at or around 2.0%, or 20 times as high.  

It’s a big difference—and one that can have a big impact for consumers. Traditional savings account interest rates lag behind inflation, or the rate at which money loses purchasing power, while high yield savings accounts frequently beat inflation. So, the difference in APY can be the difference between your savings gaining value and losing it.

There are several advantages to using a high yield savings account:
•    You can earn a meaningful return on your balance. 
•    The money remains accessible but at arm’s length from your day-to-day finances. 
•    You can use a high yield account as a dedicated account for a specific savings goal. 
•    Since it’s a savings account, your balance is insured up to $250,000 by the FDIC.

When to Open a High Yield Account
Many people open high yield savings accounts when they are saving for a large expense. That could be a vacation, a down payment on a house or a car, a home renovation, a wedding or something else. 

Along with the benefit of greater interest, a high yield savings account also keeps targeted savings separate. The money is “out of sight and out of mind,” says Jorie Johnson, a certified financial planner and the founder of Financial Futures LLC in Brielle, New Jersey. “It’s not linked to your debit card and you can’t spend it on a whim, so it helps with discipline.”

A high yield savings account can also be useful for your emergency fund. Having three to six months’ worth of expenses accrue interest is better than watching the money slowly lose value from inflation. And with a high yield account, your money is easily accessible when the unexpected happens.

For some, a high yield savings account is one aspect of a balanced financial portfolio. Since high yield savings accounts are FDIC insured, and therefore secure, they balance more volatile assets, such as stocks. In 2018, for example, high yield savings accounts outperformed the stock market; both the S&P 500 and Dow Jones Industrial Average actually lost value that year. As a result, investors with money saved in high yield accounts tempered their market losses that year: What their savings accounts gained in value partly offset what their stocks may have lost. 

How to Assess a High Yield Account
When choosing a high yield savings account, there are a few things you’ll want to know before you can tell if it’s going to work for you:
•    Monthly maintenance fees. These vary by institution, and some banks don’t charge any. It’s important to have this information, because you’ll need to subtract any fee from your account’s projected earnings to figure out the actual return you’ll be receiving. 
•    Minimum balance and initial deposit requirements. They could be as low as $0, or as high as several thousand dollars. 
•    Transaction limits. As with traditional savings accounts, high yield savings accounts may put a limit the number of withdrawals and transfers you can make in a month. 
•    Annual percentage yield and rate of compounding. The more often the interest compounds, the higher the annual percentage yield (APY) will be. 

With this information in hand, you’ll be ready to move your savings to an account that will help your money grow faster.

This chart is titled "Going on Vacation with a High Yield Savings Account" Simran wants to take her family on vacation in three years and needs to save $4,500. To reach her goal, she deposits $125 every month into a high yield savings account. The account has no maintenance fee and a 2.25% APY that compounds monthly. Because she uses a high yield savings account, Simran reaches her goal a month early.

Erin Heger is a freelance journalist located in the Kansas City area. Her reporting and essays have been featured in The Atlantic, LearnVest and Northwestern Mutual’s Life & Money series.

See today’s rates and open a Synchrony Bank High Yield Savings Account online.

This article is part of Synchrony Bank’s Personal Finance Series: Level 101. View all topics in the series here.