Breaking Into Saving: Understanding Savings Account Rates

You may have heard people talking about “the power of compound interest” before. It might sound a little grandiose, but it’s true. This term refers to the snowball effect that happens when you earn interest not only on the original money you invest, but on the interest you earn from this investment. As such, compound interest is a powerful tool for growing your wealth, and is an important factor to keep in mind when choosing a savings account. After all, when used intelligently, savings accounts are not simply a place to store your money, but a place to grow your money.

How Savings Account Rates Are Calculated

Assume you put $1,000 into a savings account that paid 1% interest per year and didn’t charge any fees. At the end of one year, assuming you didn’t take out or add any money to the account, you would be left with $1,010: $1,000 + (1% x $1,000).

However, this calculation actually determines simple interest, not compound interest. Because savings accounts pay interest more than once a year, the interest that gets added into your account also earns interest. So, presuming your account compounds interest daily—meaning that every day the amount in your account grows by another 1/365th of 1%—the savings account in the previous example would actually have $1,010.05 at the end of one year.

Now, let’s imagine that instead of leaving your original deposit in your account to grow on its own, you are regularly contributing more money your savings. Say you deposit a further $100 a month into this account. After one year, you would have earned $16.57 in interest.

So, how does this all look to you, the customer? Well, when financial institutions advertise their savings account rates, they will display them in the format of x.xx% Annual Percentage Yield (APY). Note that this figure already takes into account compounding effects. For example, going back to the example above, the final amount in the account was $1,010.05, which is a total return of 1.01% over a year. Hence, financial institutions advertise the savings account rate as 1.01% APY, as that is the interest your money will earn in a year.

Different Types of Savings Accounts

Savings accounts are largely differentiated according to four main factors: interest rates, minimum balances, withdrawal conditions, and fees. Interest rates refer to the APY, and typically the higher the APY offered, the higher the required minimum balances and the stricter the withdrawal conditions. Fees can include items such as monthly service and inactivity fees, ATM withdrawal fees, and account closure fees.

For example, at Citadel, we offer four different types of savings accounts. These are all federally insured up to $250,000 per member by the National Credit Union Administration.