It’s hard to imagine living without a checking account these days. Online purchases? No problem. Direct deposit? Yes, please.
A savings account, though, is a low-key aspect of finance. If you’re making automatic deposits, then it’s quietly working in the background. And if you’re low on funds like most young adults, then it may feel unnecessary. Why open a separate account when you can just leave it in checking until you need it?
There are tons of excellent reasons to have and use a savings account. One of the most beneficial reasons is called compound interest — and if you use it strategically, it becomes a form of passive income and a rainy-day fund all at once.
How compound interest works
If you have a credit card or a car loan, for example, then you’ve heard of annual percentage rates, or APR for short. APR is the interest that you’re charged on your accounts and are responsible for paying.
Well, when you have a savings account, instead of paying APR, you earn an annual percentage yield or APY. Think of APR as money potentially leaving your account and APY as money potentially coming into your account.
With that in mind, when you store your money in a savings account, financial institutions pay interest for keeping it there. For example, the OCCU Ignite Savings pays up to 5.25% APY.
Interest is calculated as a percentage of your savings that gets added to your balance at regular intervals. For the math-inclined, the formula is as follows:
APY = [1+ (i / n)n - 1
i = interest
n = how many times interest compounds in a year.
For those who prefer words to formulas, here’s a classic example of how compound interest works. You may have heard it before.
Imagine that one day you receive a grain of rice and every day the amount of rice you have will double. So, on day one, you have one grain. On day two, you have two grains, on day three, you have four. Day four, you have eight grains of rice. Day five? Sixteen.
Two things are true in this scenario. The first is that your rice grows exponentially. And two, the amount of rice you gain each day is based on the amount of rice you start with. To translate that to savings accounts, the more money in the account, the more compound interest you earn.
To be clear, no savings account is going to earn double the account balance daily. This scenario is just an example explaining how compound interest works.
Choosing the right savings account
To maximize your savings potential with compound interest, you want to get the highest interest rate possible.
Since checking accounts are meant to be transactional accounts you withdraw from frequently, many banks don’t pay any interest on them — no matter how high your balance. OCCU does, however. A new Remarkable Checking account, for example, pays a great rate on balances up to $20,000 if certain qualifications are met each month.1
But there’s something to be said for an account that’s less transactional. OCCU has a variety of savings accounts that will have you earning more and saving more. You’re encouraged to keep your money in your savings accounts to earn the best interest rates. But your money is always accessible.
In comparison, other high-yield savings options, like a certificate of deposit, give you a guaranteed rate, but in exchange, you won’t be able to access your money without penalty.
There’s an account for every saving strategy!
With the right savings account and enough time, you can use compound interest to accelerate your savings potential. Take advantage of compound interest. Open an Ignite Savings account today.
