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When you accrue interest on a principal amount and then periodically accrue more interest on both the existing interest and principal, you have what's known as compound interest. For example, if you have $100 dollars and receive 5% compound interest annually, you will have $105 dollars at the end of the first year, $110.25 at the end of the second year, $115.76 at the end of the third year, and so on.
This can be contrasted with simple interest, wherein interest is paid based on a fixed amount. If you receive simple interest of 5% each year on $100 dollars, you will have $105 dollars after the first year, $110 dollars after the second year, $115 dollars after the third year, and so on. - A compound interest savings account allows you to earn periodic interest payments based on the current amount in your savings account. Banks usually prorate and compound interest daily: if you receive a 2% annual interest rate, each day you will accrue 1/365th of that amount (2% of your principal) in interest. You will usually be paid that interest on a monthly basis.
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There are two types of savings accounts: passbook savings accounts and high-yield savings accounts. Passbook savings accounts are low-fee accounts, wherein you are given a a small ledger in which all deposits, withdrawals, and other transactions are recorded. These accounts usually do not require a minimum balance, and often have limitations on the number of withdrawals you may make to encourage you to save.
High-yield savings accounts, by contrast, usually require you to maintain a certain minimum balance to avoid the levying of monthly service charges. This account yields a higher interest rate than a passbook savings account.
While not technically a savings account, a Certificate of Deposit (CD) is a savings vehicle that employs the principle of compound interest. You deposit a certain amount of money for a fixed term during which you will receive a relatively high interest rate. For example, if you buy a 3-year CD for, say, $500 dollars, you agree not to withdraw the money for 3 years in exchange for a periodically compounded interest rate that is higher than a savings account interest rate. -
There are several benefits to opening and maintaining a savings account. You are able to accrue savings much faster than if you keep your money in other vehicles, such as a no-interest checking accounts, due to the compound interest.
Savings accounts, backed by the FDIC, are insured from loss, making them extremely safe and secure.
Savings accounts are also extremely liquid, meaning you can remove your money from them easily in the case of an emergency or to meet a short-term financial goal. - When choosing between savings accounts, you should always consider whether the interest rate outweighs all applicable fees. After all, if your balance is $1,000, the interest rate is 1% a year, and you must pay a $5.00 dollar monthly surcharge, you lose the primary benefit of the savings account: accrued interest.
