Are you earning the best savings account rate?
The interest rate on your savings account is crucial to calculating how much your balance will grow. It’s important that you earn the maximum variable rate of interest to build on your savings as quickly as possible, but sometimes the rate quoted doesn’t match the interest returns you receive.
Compare the best interest rates below
How do variable rates work for savings accounts?
If you open a high-interest savings account, the money you deposit will earn interest at a variable rate. This rate is regularly adjusted by your bank in line with fluctuations to the federal funds rate. In other words, the maximum variable rate of interest you can earn will go up and down over time.
In some cases, you may find that the interest earned on your account doesn’t match the maximum variable rate quoted, and the fluctuations are more than you’d expect. There are a few reasons this can occur:
Introductory interest rates
There’s the introductory rate that a bank uses to get you in the door, and then there’s the long-term rate applied to your account. Some banks — particularly smaller ones — will temporarily raise their interest rates above the usual level. Then, in a few months, they drop back down.
When opening an account, look at the historical interest rates the bank has offered — major swings can be a red flag.
Karen opens a savings account with a small bank that offers an introductory rate of 3%, but after six months the rate drops down to 1.5%. Josie looks into the historical rates of her bank before opening an account to make sure her interest rate won’t vary too wildly, and her rate of 3% stays the same over the course of the year.
|Interest rate||3%||3% for the first six 6 months, 1.5% for the second 6 months|
As the table shows, even though Karen and Josie deposited the same amount of money, Karen earned $1,148.92 less because her interest rate changed.
The type of interest rate you have
Another important factor that affects the interest you can earn on your savings balance is whether your account pays simple interest or compound interest. Simple interest is only paid on the money you deposit into your account, but compound interest allows you to earn interest on the initial deposit and the interest payments you receive — in other words, you can earn interest on your interest.
How often interest is compounded
The interest on your account could be compounded daily, monthly, quarterly, biannually or annually, and the frequency with which it occurs can make a surprising difference to your balance. The more interest is compounded, the more chances you have to earn interest on your interest.
Adam is in his early 20s and wants to start saving for a house. He has an initial investment of $5,000 and plans to deposit $500 each month for the next five years. Assuming an interest rate of 5%, let’s look at how Adam’s balance differs based on whether interest is compounded daily, monthly or annually.
|Account A||Account B||Account C|
|Ongoing monthly deposit||$500||$500||$500|
|Investment term||5 years||5 years||5 years|
Adam can earn more interest by choosing an account that compounds interest daily. In fact, after five years, he ends up with an extra $143.53 compared to an account that compounds interest annually.
Tiered interest rates
Some banks have different interest rates depending on how much money is in your account. For example, balances below $10,000 could have a rate of 0.5% while balances that exceed $10,000 have a 1.5% interest rate. With multiple rates potentially applying to your account, the maximum variable rate available will fluctuate with your bank balance.
Interest rate changes
One other risk to be aware of is that your bank may have changed the interest rate that applies without you knowing. Although banks are required to advertise interest rate changes in national media when they occur, these announcements could easily slip by without you noticing.
The new interest rate will then be reflected in your account statement. Depending on how often you receive statements and how closely you read them, it could be some time before you realize that the maximum variable rate on your account has changed.Back to top
How to earn the best interest rate
Taking the above examples into account, there are a few simple steps you can take to ensure that you always earn the highest interest rate:
- Shop around. Before choosing an account, compare savings accounts to find one that offers a high maximum variable rate. Remember to investigate account fees, features and accessibility before you make your decision.
- Check the market. The savings account sector is a competitive area of the banking industry, with new accounts and better interest rates becoming available all the time. With this in mind, it pays to review your savings account once a year to see if you could get a better deal elsewhere.
- Check your statements. Are you worried that your bank may have adjusted the interest rate on your account without you realizing? Check your most recent statement to make sure you’re earning a competitive rate.
- Choose compound over simple interest. While simple interest accounts only allow you to earn interest on your initial deposit, compound interest accounts allow you to earn interest on your interest.
- Check how often interest is compounded. The more often interest is compounded, the more your balance will grow. An account that compounds interest daily or monthly will earn more than an account that compounds annually.
Opening a savings account with a variable interest rate can help you take advantage of shifts in the market to earn the highest return on your account. However, two accounts that advertise the same interest rate can pay very different returns by the time you need your money back.
To get the most out of your account, shop around for the terms and conditions that will save you the most.