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For over a generation, savings accounts paid so little interest that it wasn’t worth the trouble. But with rising interest rates, high-yield savings accounts can actually help you stave off the erosion of inflation. Compared to a standard checking account, a high-yield savings account could earn you an extra $52 per year, for every $1,000 you have in your account!
Comparing a high-yield savings to a checking account
To compare the interest earned from a thousand dollars in a checking account versus a savings account with an Annual Percentage Yield (APY) of 5.25%, we need to understand the key differences between these two types of accounts:
Standard Checking Account:
A checking account is designed for everyday transactions. It typically offers easy access to funds through methods such as debit cards, checks, and electronic transfers. However, checking accounts usually offer very low or even negligible interest rates. As of my last knowledge update in September 2021, the interest rates for checking accounts are usually around 0.01% or lower.
Savings Account with APY of 5.25%:
An APY of 5.25% is quite high for a savings account. APY takes into account compounding interest, which means you earn interest on both your initial deposit and the accumulated interest from previous periods. With an APY of 5.25%, the interest compounds over time, leading to higher overall returns compared to a simple interest rate.
Calculating the difference in interest between high yield savings and checking accounts
Most of you aren’t going to be interested in the actual math. You will probably just want to see what the results are. This is where you can skip the equations and see the results. For those of you are interested in seeing how the sausage is made, let’s calculate the interest earned in both scenarios:
Checking Account calculations:
Assuming a checking account with an interest rate of 0.01% (which is a common rate for checking accounts):
Interest Earned = Principal × Rate
Interest Earned = $1,000 × 0.0001 = $0.10
Savings Account with APY of 5.25% calculations:
For a savings account with an APY of 5.25%, we’ll need to calculate the compounded interest. The formula for compound interest is:
A = P × (1 + r/n)^(nt)
Where:
A = Total amount after interest
P = Principal amount ($1,000)
r = Annual interest rate (5.25% or 0.0525)
n = Number of times interest is compounded per year (assuming once)
t = Number of years
In this case, let’s assume the money is kept in the savings account for one year:
A = $1,000 × (1 + 0.0525/1)^(1×1)
A = $1,000 × (1.0525)
Therefore: A = $1,052.50
Interest Earned = Total Amount – Principal
Interest Earned = $1,052.50 – $1,000 = $52.50*
Comparing the two scenarios:
- Checking Account: $0.10 interest earned
- Savings Account with 5.25% APY: $52.50 interest earned
High Yield Savings Accounts give you an extra $52.40 every year for each $1000 saved
As you can see, the interest earned from a savings account with a 5.25% APY is significantly higher than the interest earned from a checking account with a 0.01% interest rate. This demonstrates the importance of higher interest rates and the power of compounding in growing your savings over time. Keep in mind that actual interest rates can vary, so it’s always a good idea to check with your financial institution for the most up-to-date rates.
Footnote
*The real nerds out there will notice that high-yield savings accounts will award interest monthly and will compound on the new balances. That means that the real amount at the end of the year would be $0.12 higher than what we are showing here, but we simplified an already complicated idea and thought explaining where the extra twelve cents came from might be a bridge too far.
