The Basics of a Savings Account

You know that saving money is important to your financial well-being. But where do you start? Here are a few basics to point you in the right direction.

How Do Savings Accounts Work?

A savings account helps you save money and rewards you with a little extra money in return, called interest. Interest is paid to you by the financial institution or bank holding your money. Banks pay you interest because it benefits them to hold money and lend it to others.

APY and Compound Interest

The interest rate banks generally offer customers for savings accounts is known as annual percentage yield (APY). The difference between a simple interest rate and APY is that APY includes the amount of money you will earn for a period of one year on your principal investment, plus the accumulated compound interest.

With compound interest, you not only earn interest on your initial investment, but also on the interest itself. And with most savings accounts at a bank, that interest is compounded daily for the entire time the money is invested. Think of the extra money you earn growing a little bit more on top of itself every day.

As you can imagine, the benefit of compound interest increases as more money is invested for longer periods of time. For instance, if you save $100 a month for 10 years, at an APY of 1.5%, your ending balance will be $12,954.81. That's $954.81 in interest earned, just for being a good saver and putting money in the bank.

Choosing the Right Savings Account for You

When selecting a savings account, there are a few more things to consider than just the interest rate. You'll want to understand your options for depositing, transferring and withdrawing money, as well as understand the types of fees that might be associated.

The Federal Reserve limits the permissible transactions for savings accounts to no more than six per monthly statement cycle (Regulation D). This doesn't apply to transfers or withdrawals made using the ATM, in person or by mail. Banks are required to make sure you stay within this limit—otherwise, you may have to close your account or change it to a different type of account like a checking account. In addition, your bank may charge you fees for the excessive transactions. You should also ask whether the account has a maintenance fee or any other usage fees that could decrease your savings balance.

The Bottom Line

A savings account can be a great contribution to your financial well-being. When choosing a savings account, remember to look for a competitive annual percentage yield and some flexibility to make transactions. Try to avoid accounts with multiple fees that can eat into the interest you earn. Once you open your account, continue to contribute regularly and enjoy watching your money grow.

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