Tuesday, April 16, 2024

The Compound Period Matters for Savings Accounts

How do you choose the best compound period for your emergency funds savings account? Those saving for retirement already know that a savings account is one of the least attractive options if you are looking to grow your money quickly, but having an emergency savings is an essential step in protecting your investment. Many people choose a traditional savings account as a safe place to keep their emergency fund, but there is no reason why you should not get the most from your emergency savings and allow it to build. Understanding compounding periods is a factor that is as important as the APY to help you choose the right bank account and grow your savings. 

Traditional Savings Accounts for Your Emergency Fund

Financial planners stress the importance of having an emergency fund of at least three to six months stashed somewhere that is easily accessible, but not in your checking account. Savings accounts are a popular place to stash cash because you can quickly withdraw it if the need should arise, but it is out-of-sight and out-of-mind when a tempting impulse purchase comes along. An emergency fund is an essential part of protecting your investments. It can help you handle the minor mishaps in life that occur, such as car repairs, medical expenses, or home repairs, without having to get money from your retirement account. 

Withdrawing money early from your retirement account can cause you to incur hefty fees, and some accounts will not even allow early withdrawals. In addition, early withdrawal from your higher-interest retirement account means that you miss out on the interest that money could have earned in the future, too. That is why having a separate emergency savings account is so important, but there is no reason why you should not allow it to grow, too. Even though savings accounts do not offer as high interest as other investments, at least your money is growing while it is on standby in case of an emergency. 

Traditional Savings Accounts for Your Emergency Fund

Choosing a Savings Account

When choosing a savings account, many people only look at the annual percentage yield (APY). While this is important in getting the most for your money, other factors can have a more significant impact on savings growth. For example, most banks are currently at an APY of around 0.50 to 0.60%, which is not as attractive as the average 7% that you could earn in the stock market. 

The first thing to make sure is that the bank offers compound interest so that you will earn interest on the interest, allowing your account to grow more quickly over time. One thing to watch out for is that some banks will advertise higher rates to draw you in, but these rates are for simple interest and not compound interest. This means that you will not earn interest on the interest, only the initial interest that you deposit. So even though the interest rate sounds higher, you could earn less over time than with a compound interest savings account at a lower rate. 

Another thing to watch out for is teaser rates. This is where the bank offers a higher interest rate for a certain period, and then the rate is reduced. An additional factor that you need to watch for with teaser rates is that sometimes, they will make you agree to keep your money in their bank for a certain amount of time to earn the higher rate. They often will not pay out the higher interest rate until you have met the minimum deposit length of time requirements. You cannot just get the higher interest and then move your money after the regular rate kicks in without a penalty. 

Understanding Compound Periods

Understanding Compound Periods

The compounding period is one of the most important things to understand when choosing a place to stash your emergency savings. This is how often the interest earned is calculated. Many regular savings accounts may compound the interest monthly, but some compound it daily. Some banks offer money market accounts and CDs that compound daily. 

The bottom line is that compounding daily earns you much more money than compounding monthly because the interest money is added to the account and begins earning interest more often. To see the difference, you can use this compound interest calculator. Switch the “compound frequency” from monthly to daily, and you can see just how much difference there is.

Suppose you want to see what you would earn in a simple interest account at a higher rate as compared to compound interest at a lower rate. In that case, you can use the compound interest calculator and compare it to the results you get with this simple interest calculator

As you can see, there is more to deciding which savings account will be the best place for your emergency savings than just looking at the advertised APY. You have to compare the type of savings and know how often it compounds. Therefore, it is always best to make sure you thoroughly read the documents before signing up for a savings account for your emergency fund.

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