The best compound interest accounts perform the wonderful trick of earning money on your money. This is especially useful in today’s high-rate environment, and for anyone who tried to save over the preceding 15 years when yields were lackluster.
Still, not all compound interest accounts are the same, so It’s important to know which ones best fit your needs.
Savings
A savings account is a compound interest account that keeps your money accessible. Depending on your bank, interest may compound daily, monthly, quarterly or annually. Interest rates can vary widely, from 0.01% to above 5.00% APY in a high-yield savings account.
One of the benefits of a savings account is that when connected to a checking account at the same financial institution, you can transfer funds immediately. That makes it a great option when you want to keep some of your savings liquid while still earning compounded interest.
Certificates of deposit CDs
A certificate of deposit (CD) is a type of account that locks in an interest rate until the CD matures — but your money is typically locked in as well. If you withdraw funds before the end of the term, you’ll incur a penalty, usually in the form of lost interest.
CD terms range anywhere between 1 month and 10 years. During that time, interest compounds unless you choose to have earnings deposited into a different account.
When you opt for compounding interest, your bank or credit union may compound the interest either daily or monthly. Either way, it is typically applied to your account on a monthly basis.
Money market accounts (MMAs)
A money market account is another type of savings account. It’s like a cross between a checking and a savings account. Like a high-yield savings account, you usually get better rates than you would in other types of interest-bearing accounts. Typically, money market accounts compound daily.
However, you can usually write checks from your money market account, but it’s not intended to be used as a checking account so some banks will place a limit on the number of withdrawals they allow per month.
Interest checking accounts
Some checking accounts also offer compound interest. This type of account is best for daily transactions and lets you access your money through debit cards, ATMs and checks.
There are often some requirements you must meet in order to earn the advertised interest rate. For example, you may need to make a certain number of debit card transactions, or have direct deposit.
What is compound interest?
Compound interest is when you earn interest on both money you’ve contributed to an account, as well as previously paid interest from your financial institution. Over time, this phenomenon can earn you large sums of money that you wouldn’t otherwise have. The higher the interest rate and the longer you keep that money in an interest-bearing account, the more you’ll accumulate over time.
How does compound interest work?
Interest may compound daily, monthly or annually. The more frequently the interest compounds, the more you’ll earn over time. Here’s an example of how compound interest works over time.
Let’s say you have an interest-bearing account with a starting balance of $5,000. You don’t make any contributions or withdrawals for 10 years. Here’s what your ending balance will be with different rates when interest compounds monthly.
- 1% yield: $5,526
- 3% yield: $6,747
- 5% yield: $8,235
In this example, without any additional contributions, compounding interest grows the account anywhere between $526 and $3,235.
Factors to consider when choosing a compound interest account
There are a few considerations when choosing a compound interest account. First is the yield you’ll earn on the account. You can see above how different interest rates will affect growth over time.
Secondly, consider any fees you’ll be charged; even a small fee will greatly reduce the effects of compound interest. Also, be aware of any requirements for the account; there may be certain requirements, such as maintaining a minimum balance, to earn the highest advertised rate.
The compounding frequency does matter, but not as much as you might think. Taking the example above, a $5,000 balance earning 5% compounding monthly earns $3,325 in interest over 10 years. If it is instead compounded daily, you’d earn $3,243 over that time period. That’s a difference of $8.
Tips for maximizing income in compound interest
In addition to finding the highest yield, also take advantage of the power of time. That means contributing to compound interest accounts as early as possible.
For instance, say you open an account at age 35 with a $10,000 opening balance and a 5% yield that compounds daily. By the time you turn 40, that account will have a balance of $12,840.
But if you had made the same deposit five years earlier at age 30, the account would be worth nearly $16,500 by the time you hit 40.
Frequently asked questions (FAQs)
Putting your money in a high-yield savings account is likely your best bet to earn compound interest.
The best high-yield savings accounts earn a high yield without fees or large balance requirements.
It depends on the type of compound interest account. Checking, savings, CDs and money market accounts are usually secure. Make sure your bank is insured by the FDIC (or the NCUA for credit unions).
Most banks offer savings accounts with compounding interest. Check out our list of the best online banks to find a good fit for you.
How frequently an account compounds interest depends on the bank. Most savings accounts compound daily. It can be difficult to find compounding schedules on the bank’s website, but you can always call customer service if you are unsure.
