How to Gain Interest on Your Money

Interest represents the cost of borrowing money or the reward for lending it, typically expressed as a percentage of the principal amount. When you deposit money into a savings account, for instance, the financial institution essentially pays you for the use of your funds. This payment is called interest.

A significant aspect of earning interest is compounding, which means earning interest not only on your initial deposit but also on the accumulated interest from previous periods. This “interest on interest” effect can lead to exponential growth of your money over time, accelerating your financial progress.

Basic Savings and Checking Accounts

Traditional savings accounts at banks and credit unions serve as a common starting point for earning interest on deposited funds. These accounts provide a secure place to store money not needed for immediate expenses. Financial institutions typically calculate interest on the account balance and pay it out periodically, often on a monthly or quarterly basis.

While the primary function of a checking account is to facilitate everyday transactions, some checking accounts may also offer minimal interest. However, the interest rates on these accounts are generally lower than those found in savings accounts.

A key characteristic of both basic savings and checking accounts is their high liquidity, allowing depositors relatively easy access to their funds. These accounts also have low barriers to entry. Deposits held in these accounts are typically protected by federal deposit insurance, up to $250,000 per depositor per institution, through the Federal Deposit Insurance Corporation (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions.

High-Yield Deposit Products

High-yield savings accounts (HYSAs) offer a way to earn significantly more interest than traditional savings accounts. These accounts operate similarly to standard savings accounts but distinguish themselves by providing a higher annual percentage yield (APY). HYSAs are commonly found at online banks and some credit unions, which can often offer more competitive rates due to lower overhead costs.

Money Market Accounts (MMAs) blend features of both savings and checking accounts. They typically offer higher interest rates than basic checking accounts and often surpass standard savings account rates. MMAs allow for a limited number of transactions, including check-writing capabilities or debit card access, while generally requiring higher minimum balances than basic savings accounts. Their interest rates are variable and tend to adjust with broader market rate changes.

Certificates of Deposit (CDs) are time deposits where you agree to keep your money locked up for a fixed period, ranging from a few months to several years. In exchange for this commitment, the financial institution typically pays a fixed interest rate for the entire term. Interest on CDs can be paid at maturity or periodically throughout the term, depending on the specific product.

Longer CD terms generally offer higher interest rates. However, withdrawing funds before the CD’s maturity date usually incurs an early withdrawal penalty, which can reduce the interest earned or even dip into the principal.

Fixed-Income Investments

Beyond traditional deposit accounts, fixed-income investments, such as bonds, offer another avenue for earning interest. A bond represents a loan made by an investor to a borrower, which could be a government or a corporation. In return for this loan, the borrower agrees to pay the investor regular interest payments, known as coupon payments, over a specified period. At the end of the bond’s term, called the maturity date, the original principal amount is returned to the investor.

Several types of bonds exist, each with distinct characteristics. Treasury bonds, notes, and bills are debt instruments issued by the U.S. government, widely considered to have very low risk due to the backing of the full faith and credit of the United States. Treasury bills are short-term, typically maturing in less than one year, while Treasury notes have maturities between two and ten years, and Treasury bonds mature in over ten years.

Corporate bonds are issued by companies to raise capital. The interest rates offered on corporate bonds often reflect the issuing company’s financial health and creditworthiness; companies with higher perceived risk typically offer higher interest rates to attract investors. Municipal bonds, or “munis,” are issued by state and local governments to finance public projects. A notable advantage of municipal bonds is that the interest earned is often exempt from federal income tax, and sometimes from state and local taxes as well, particularly if you reside in the issuing state.

Individuals can invest in bonds through various channels. Direct purchases of government bonds, such as Treasury securities, are possible through platforms like TreasuryDirect. For a broader selection of corporate and municipal bonds, investors can utilize brokerage accounts. Alternatively, bond mutual funds and Exchange Traded Funds (ETFs) provide a diversified way to gain exposure to a portfolio of bonds without needing to purchase individual securities. These funds pool money from many investors to buy a variety of bonds, offering professional management and instant diversification.