What is a high-yield savings account, and how does it work?

When you want to grow your money, interest counts. That's why it's important to look beyond basic savings accounts.

One option to explore is high-yield savings accounts. They offer higher interest rates than traditional savings accounts—which helps your money grow faster. Plus, unlike certificates of deposit (CDs) or market investments, you can add or withdraw funds at any time without a delay or fees.

Learn how high-yield savings accounts work, how they compare with traditional savings accounts, their advantages and drawbacks, and how they could be a part of your overall financial strategy.

High-yield savings accounts, or HYSAs, are a deposit account that allows you to earn higher than average interest on your money. You make an initial deposit, and you can add to it or make withdrawals over time, just like with a basic savings account. These accounts keep your cash safe while also making it available to you when you need it.

You can find HYSA options at banks or credit unions, most of which offer online and mobile banking with 24/7 access to your savings account. Some institutions require starting with a minimum balance—often $1,000 or more—and may waive any account fees as long as you stay above a certain amount. Opening one is as easy as filling out an application with your preferred financial institution and having cash or a transfer ready to fund it.

Financial institutions can vary on the features offered with their high-yield savings accounts, but you'll generally have:

• FDIC or NCUA insurance on deposits up to $250,000 per account, per person, per institution
• Competitive interest on deposits
• Online, mobile and ATM access to your account
• Ability to transfer money between accounts

HYSAs and regular savings accounts mostly differ in the interest rates they offer. HYSAs frequently feature rates more than 10 times the interest rate you'd get on a traditional savings account.

Two tradeoffs for getting a higher rate are that you may be required to maintain a higher balance than you would for a basic savings account and you may be limited to a certain number of transactions per month.

HYSAs have cash-like liquidity, and you can withdraw from them as easily as basic savings accounts. Unlike CDs, retirement accounts and annuities where you generally can't withdraw money before a certain point in time without paying a fee or sometimes a tax penalty, you generally can withdraw money from—and add money to—your HYSA as needed.

HYSAs can have some potential withdrawal restrictions to be aware of:

• Some institutions limit the number of withdrawals you can make per month, often capping them at six and imposing a penalty for each additional withdrawal. Watch for account agreements that say your HYSA will be closed or converted to a standard checking account if you make excessive withdrawals.
• Institutions also can set a dollar limit on different transaction types. For example, ATM withdrawals may be limited to $500 per day or transfers capped at $5,000 per instance.
• You may be required to maintain a minimum balance. If your withdrawals leave your account below the HYSA's minimum balance, you may have to pay fees.
  

The returns you can get from an HYSA is tied to market factors like the Federal Reserve's interest rate policies and individual bank guidelines. When the Fed raises or lowers the general level of interest rates to influence the economy, the rate earned on HYSAs follows suit. These factors change over time so it's important to regularly check on your high-yield savings accounts and be sure you understand what you're getting.

Like other savings tools, high-yield accounts let you take advantage of compound interest, where the interest you accrue is folded into your balance and then helps you accrue more interest.

To see how it works, let's say you have $1,000 in an account that earns 5% compounded annually:

• Over one year with no additions or withdrawals, the account would earn $50.
• At the end of the year, that $50 would become part of your principal, making your new balance $1,050.
• The second year, you would accrue 5% interest on not just $1,000 but $1,050.
• At the end of the next year, you'd have gained $52.50, making your new balance $1,102.50.
• The third year, you would accrue 5% interest on $1,102.50—$55.13—and have $1,157.63 at the end of the year.
• And so on. (Plus, imagine if you were also adding deposits to your balance; it would grow even faster.)

The interest rate on an HYSA is often listed as annual percentage yield (APY). This figure can be slightly different from the nominal interest rate, and it's important to evaluate it when analyzing or comparing accounts.

The APY takes into account how frequently the balance accrues compound interest, presenting your interest rate in terms of the total amount of interest you'll get across a year. For example, compare the same rate with different accrual periods:

• A 5% interest rate that compounds annually has an APY of 5%. It earns 5% in a year.
• A 5% interest rate that compounds monthly has an APY of 5.12%. It earns 5% every month based on the new monthly total with previous interest included.
• A 5% interest rate that compounds daily has an APY of 5.13%. It earns 5% every day based on the new daily total with previous interest included.

Knowing the APY allows you to make an equal comparison of accounts that may have different interest rates and accrual frequencies.

HYSAs are generally better for short-term goals, letting you boost your current savings while still giving you easy access to your money. For long-term savings, investments like retirement-specific accounts generally hold up better against inflation over time.

Easy access to your cash. If you're saving for an upcoming vacation, starting an emergency fund or making a down payment on a home in the near future, a high-yield savings account can provide the flexibility to withdraw your money easily when needed. You'll just need to keep any withdrawal limits in mind and plan strategically.

Stable returns. High-yield savings accounts typically offer a stable and predictable interest rate, providing a secure environment for short-term savings. This can be reassuring when you want to protect your principal.

More time could equal more money. For long-term savings goals, such as retirement planning, saving for a child's education or building wealth over time, HYSAs can help you accumulate more money.

Stay wary of inflation. Be aware that interest rates on high-yield savings accounts may not always keep up with inflation, limiting their long-term utility.

Diversify your savings. High-yield savings accounts can offer solid returns, but it's important to consider diversifying your long-term savings. Explore additional investment options like CDs, stocks, bonds or retirement accounts to optimize your long-term savings strategy.

It's important to consider diversifying, especially for savings intended for your long-term goals. HYSAs and other savings and investment vehicles can help build out your complete plan when each instrument is used for its intended purpose.

Combining HYSAs with additional investment options like CDs, stocks, bonds or retirement accounts can optimize your total savings strategy.

HYSAs have attractive features, but they might not be the right fit for every saving situation.

• Higher interest rates. The primary advantage is the potential to earn a higher interest rate compared with traditional savings accounts.
• Accessibility. HYSAs give you easy access to your money through online and mobile banking platforms. Unlike a CD or retirement assets, these accounts let you get your cash when you need it. You can conveniently make withdrawals, transfer money and track your balance.
• Safety. Just like traditional savings accounts, but unlike market-based investments, high-yield savings accounts offered by reputable banks come with FDIC protection. Even if the bank fails, your deposits are insured up to $250,000 per depositor, per insured bank.

• Potential for rate changes. While HYSAs may offer appealing interest rates initially, the rates could change over time. Rates are influenced by market conditions and the policies of the financial institution.
• Online limitations. If your account is offered by an online bank without physical branch locations, you could be disappointed if you prefer in-person banking services, have limited internet connectivity or need assistance with transactions.
• Possible account restrictions. Some HYSAs require you to keep a minimum balance or limit the number of transactions you're allowed per month or year. It's essential to review the account terms to ensure they align with your needs.

It's important to think about your personal banking preferences, financial goals and the services of different institutions before deciding on a high-yield savings account. Generally, keep an eye out for these factors during your search:

• High interest rate. Seek an account that offers competitive interest rates.
• Low fees. Look for accounts with minimal or no fees, such as monthly maintenance or transaction fees.
• Little or no minimum balance requirement. If you prefer flexibility, look for accounts with low or no minimum balance requirements.
• Easy account accessibility. Determine if the bank offers a user-friendly banking platform that allows you to easily manage your account.
• Solid reputation of the financial institution. Research the credibility of the bank. Look for a well-established institution with a strong track record and FDIC insurance.
• Additional account features. Consider perks that might enhance your experience, such as automated savings tools, goal tracking, a budgeting app or joint account options.