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How to Open a Compound Interest Account

Learn what compound interest is and how to open an account that offers it

Albert Einstein once described compound interest as the eighth wonder of the world. Compound interest is what you earn from the combined amount of interest paid on your savings and the savings themselves. This then allows a greater amount of savings to grow even more.

In other words, you earn interest on your interest. As you build your savings with past interest payments, you receive a higher return each subsequent year. This is thanks to exponential growth from compounding.

You don’t have to be a Nobel Prize winner like Einstein to benefit from the power of compounding. Here’s how to open a compound interest account and what you should research before signing up.

How to Open a Compound Interest Account

Investopedia / Zoe Hansen

How to Open a Compound Interest Account

A compound interest account is any account that pays you interest on your principal and interest, and not simply on your original deposit. Such an account might be a savings account that you open at a bank or a brokerage account that you open with an online or full service broker.

Steps To Open a Compound Interest Account

Each company has its specific process for how to open an account that offers compound interest. Here is a general overview of how this works and what you should consider as you compare your options.

Step 1: Determine the type of compound interest account you need. Start by deciding what type of compound interest account you’d like. Do you want to earn a guaranteed return where you can’t lose money? If so, your best choice may be a bank offering high-yield savings accounts, money market accounts, and certificates of deposit (CDs).

Or, would you like to invest for a higher compounding rate, even if there’s a risk of short-term losses? In this case, open a brokerage account and invest in bonds, mutual funds, REITs, and stocks.

You may find a company that gives you a combination of both of the above choices. For example, with a Fidelity account, you can invest in the market and receive a guaranteed interest rate payment on your uninvested cash. 

Step 2: Compare costs, fees, and incentives. Each compound interest account has its own set of costs and fees. Some of these fees are:

  • Annual account fees: A compound interest account could charge a flat fee annually.
  • Minimum account balance fees: Financial institutions often charge a monthly fee if your balance isn’t large enough. For example, you may need to maintain an account balance of at least $500 to avoid this fee.
  • Trading commissions: Some investment brokers charge a commission every time you buy and sell securities in your compound interest account.
  • Expense ratios: If you’re investing in funds managed by a professional, the fund could charge an expense ratio as a percentage of your investment. 

The more you pay in fees, the more your return is reduced, and the less you earn overall. The best compound interest accounts keep fees as low as possible.

Look for companies that also offer incentives when you open a new compound interest account. For example, some may offer you up to a $200 bonus for opening a new savings account. Check for these as well as low fees to jump start your savings growth.

Step 3: Compare services. The services offered by financial institutions can vary. Consider the following and decide what's important to you.

  • Access to a variety of accounts: You could earn compound interest through a regular bank account, a high-yield savings account, or an investment account. You could also save through tax-advantaged retirement accounts called individual retirement accounts (IRAs) as well as college savings plans. Consider your financial goals and make sure the right accounts for you are available.
  • Product selection: Financial institutions can provide different product selections within accounts, such as mutual funds, exchange-traded-funds, stocks, bonds, and more. Research what they offer and consider how the products fit the way that you want to save or invest. Ensure that your chosen options are available where you plan to open an account.
  • Compound interest calculators and other online resources: A compound interest calculator shows how much your money could grow over time. Companies may provide other free financial tools to help you budget or stay on track to meet an important goal, such as saving for a large purchase or your retirement. Some also provide extensive educational materials.
  • Access to brick-and-mortar branches: Do you want to get help in person, or can you handle everything remotely? Some compound interest accounts offer walk-in branches, while others do not.
  • Customer service options: Companies offer assistance to their customers with different service options like phone, email, and live chat. They also have different service hours, e.g., some may offer 24 hour customer service, seven days a week. Others may offer assistance from 9 a.m. to 5 p.m, Monday through Friday. Choose a company with the customer service options that meet your expectations.
  • Support from a financial advisor: If you’d like support from a financial professional, some companies offer access to in-house financial advisors. Others leave you to plan on your own.

Step 4: Sign up for an account. Once you’ve decided where to open your compound interest account, you can formally sign up. You must provide your personal contact information, employment information, and tax ID number—usually your Social Security number. The institution needs to verify your identity to meet government regulations.

How long the application process takes depends on the type of account. You could potentially open and qualify for a bank account within an hour. Brokerage investment accounts can take as long as several days, as the broker must review your application and financial information.

Step 5: Fund your account. Last, link your current bank account to the compound interest account so you can transfer money in. Once you’ve set up the account along with any investments, you’ll start growing your savings with compound interest.

If you have uninvested cash and want to keep it that way, you can still make it work for you by putting it in a liquid interest-bearing account. See the section "Investment Platforms That Handle Uninvested Cash" below.

What You Need to Open a Compound Interest Account

As indicated above, you must submit a variety of personal and financial information to open a compound interest account. Financial institutions need this information to report your tax earnings and to meet other government regulations (concerning, for example, anti-money laundering). So expect to provide the following:

Personal Information

  • Name
  • Home address (you may need to provide proof, like a utility bill or mortgage statement)
  • Contact information, like your phone and email address
  • Date of birth
  • Social Security number
  • Driver’s license, passport, or other form of government ID

Financial and Investment Information

If you’d like to earn compound interest by investing, you must provide more financial information beyond that required by a basic bank account. The broker needs this information to determine which investment options and strategies are appropriate for you.

You may need to provide the following:

  • Employment status and occupation
  • Annual income
  • Net worth
  • Risk tolerance for losing money
  • Investment goals and objectives

Investment Platforms That Handle Uninvested Cash

Uninvested cash is cash that you haven't yet used to purchase investments. In fact, many savers keep a certain amount of uninvested cash available for liquidity purposes and as part of their diversification plan. Here are some well-known platforms that can help make your uninvested cash work for you, rather than sit idly in an account.

Platform Platform Type  Account Minimum Annual Percentage Yield Monthly Maintenance Fee
Betterment Robo-Advisor $0, $10 minimum to start investing 5.00% $0
Interactive Brokers Online Broker $0 4.83% for IBKR Pro customers with AUM of $100,000, 3.83% for IBKR Lite customers $0
Wealthfront Robo-Advisor $500 for the robo-advisor, $1 for stocks 5.00% $0
Empower Robo-Advisor $100,000 for wealth management, $0 for individual investment accounts 4.70% $0
Fidelity Online Broker $0 2.72% $0
Robinhood Online Broker $0  5.00% for Gold customers, 0.01% for regular customers Up to $6.99 for Gold customers, $0 for regular customers

Types of Lower-Risk Compound Interest Accounts

Again, if you’d like to start earning compound interest, you need to decide on the type of account you'll open. There’s a broad range of compound interest accounts, with lower to higher risk. Below are the more basic, safer compound interest accounts and what they involve.

High-Yield Savings Accounts 

High-yield savings accounts are bank accounts paying a high interest rate. The best high-yield savings accounts pay a competitive return with very low fees. Most are free. You can’t lose money in a savings account (especially if it's FDIC-insured), and savings accounts give you convenient access to your funds at any time.

If you’d like to learn more about high yielding compound savings interest accounts, see our roundup of the best high-yield savings account rates.

Money Market Accounts

Money market accounts are another bank deposit account. They typically have a higher minimum balance requirement than high-yield savings accounts. Otherwise, you may owe a monthly fee. In exchange, money market accounts usually pay a higher interest rate than savings accounts.

So if you’re willing to deposit more money, you can earn more compound interest using a money market account. These accounts have a guaranteed return and you cannot lose money. You can also withdraw funds whenever you want.

Certificates of Deposit (CDs)

When you sign up for a CD, you select the term (the time period for the investment). It could range from a month to many years. During this time, you earn a guaranteed compound interest rate. Your balance is also insured, so it won’t drop.

However, you will owe a penalty if you want your money back before the end of the agreed upon term. If you take money out early, you could forfeit interest earnings and even some of your deposit. CDs typically pay a higher interest rate than other bank deposit products in exchange for giving you less access to your money.

Bonds and Bond Funds

With a bond, you’re lending money to a government, company, or other organization for a set period of time. During this period, you receive interest payments. Typically, you get your principal (the amount you invested) back at the end of the bond term. 

Bonds have more risk and take more research than bank deposit accounts. First, you must check how safe a bond is by reviewing the issuer’s credit rating. If a bond issuer runs into financial trouble, it might not pay all the interest it owes you or even fail to pay your deposit back.

For safer bond investments, consider bonds from issuers like the U.S. government or very large, established companies. Bond rating agencies give letter grades to show the financial stability of different bond issuers.

If you want your money back before the end of the bond term, you could sell your bond to another investor through your investment platform. However, you might get back less than you paid. This happens if interest rates have increased since you first bought the bond.

If you don’t want to put in the research and work yourself, another option is to buy a bond fund. A professional investor builds a portfolio of different bonds and passes on compound interest to investors in the fund.

Mutual Funds

Mutual funds combine the money of many small investors to create a large investment portfolio. A professional investor manages the portfolio and decides on the investments.

Mutual funds have different investment objectives. For example, an income mutual fund focuses on generating income via bonds and other fixed income investments. A growth mutual fund focuses on higher-risk but potentially higher-earning investments like stocks.

There is more risk with mutual funds than with other low-risk compound interest accounts. A fund's investments may not work out, and your account balance could fall. However, mutual funds have higher earning potential than bank accounts. If you’re investing for the long term, you could potentially earn more compound interest using mutual funds.

Types of Higher-Risk Compound Interest Accounts

These compound interest investments can earn more than the basic options. But, be warned, they also require more research and you have a higher risk of losing money.

REITs 

Real estate investment trusts (REITs) are funds that invest in real estate. You pool your money with many other investors. Then, the REIT uses this money to invest in various properties. You earn a share of the profits from rent and property sales.

REITs are a way to make compound interest from real estate without going through the work and great expense of buying your own properties. Many REITs are publicly traded so you can sell to another investor and cash out at your convenience. However, non-traded REITs lock you in potentially for years.

High-Yield Bonds

With bonds, generally, the riskier the investment, the higher the interest rate that it offers investor. High-yield bonds, or junk bonds, are supposed to pay an attractive, higher coupon rate. As a result, you can earn more in compound interest.

However, high-yield bonds have an increased risk of default (hence the moniker "junk" bonds). As a result, you might only get some of the interest payments. If the issuer goes bankrupt, you may also lose your initial investment. High-yield bonds are those with a Standard & Poor’s credit rating of BB+ or worse.

Cryptocurrency

Cryptocurrencies, like Bitcoin and Ethereum, are a type of digital currency. Cryptocurrencies are decentralized and not managed by any government. If you invest in cryptocurrencies, you could make money if the price goes up.

Some cryptocurrencies also use a system called staking. If you own the cryptocurrency, you could agree to lock it up temporarily and earn an interest return paid in more cryptocurrency. Cryptocurrencies are another very high-risk, potentially high-reward investment.

Dividend Stocks

Companies issue stock to raise money. When you buy stocks, you become a part owner of a company and could share in future profits. When a company makes money, it can either reinvest it to continue growing or pay out earnings to shareholders through a dividend payment.

Dividend stocks come from companies that regularly pay dividends. These are usually larger, more established, profitable companies. Smaller companies and those trying to grow are less likely to pay dividends.

If you want compound interest from dividend stocks, research the past dividend rate of each company that interests you. Confirm as much as possible that a company can remain profitable so it will keep paying dividends.

For investment ideas, check out these top dividend stocks. If you don’t want to do this work yourself, you could look for a mutual fund focused on companies that pay dividends.

Alternative Investments

Alternative investments are those outside the conventional financial markets. These could include hedge funds, private equity funds, commodities, artwork, and farmland. Alternative investments are higher risk and require more research. For some, like hedge funds, you are required to be an accredited investor. In exchange, these investments could earn high returns.

Best Alternative Investment Platforms

Platform Focus Minimum Investment
Fundrise Real Estate Investments $10
Masterworks Art Investments $15,000
Yieldstreet Asset Variety $10,000
iTrustCapital Gold and Cryptocurrency $1,000

Factors That Affect How Much Interest You Earn

Predicting your compound interest earnings lets you see whether you’re on track for your goals. Some of the factors that determine how much you’ll earn include:

Account Balance

As the saying goes, it takes money to make money. Therefore, the more you deposit into a compound interest account, the more you earn annually.

This, along with starting to save with compound interest accounts as early in your life as possible, is the foundation of successful interest compounding. As you build your savings from the compound interest, you will make more and more per year.

Interest Rate

An account interest rate indicates how much you will earn per year on your balance. When researching how to open a compound interest account, look for one offering a competitive rate.

You should also keep an eye on market and economic changes. Rates can change, which could increase or decrease how much interest you earn per year. You should also check regularly to see if you could get a better deal from another company.

Compounding Frequency

Compounding frequency relates to how quickly your account starts earning interest on prior earnings. Accounts could compound annually, quarterly, monthly, and even daily.

The more frequent the compounding schedule, the more interest you earn per year. This is because the account starts paying a return on your past earnings sooner. If you’re interested in a daily compound interest account, our review of the best CD rates may help.

Account Fees

If your compound interest account charges fees, they will be deducted from your balance. The more you pay out in fees, the less an account balance you'll have for compounding. Therefore, look for accounts with low or no fees.

What Is Compound Interest?

Compound interest is interest that you earn on past interest/investment earnings. For example, you put $10,000 in a savings account, paying 5% yearly. After one year, you earn $500 and have $10,500 in savings. Your second year of earnings will be $525. You earn more because you’re making a return both on your initial deposit as well as past earnings. Over time, your savings grow, and you earn more and more money through compound interest.

How Does Compound Interest Work?

Compound interest works by growing your money through a bank or investment account. You first put your money into a compound interest account. It indicates how much you will earn per year. Your balance then grows by this compound interest amount. The following year, your balance plus interest earnings will continue to grow by the return. Compound interest works exponentially because you earn more and more as your savings grow.

Who Benefits From Compound Interest?

Savers and investors benefit from compound interest. As you build your account balance, you earn more each year, thanks to compounding.

On the other hand, compound interest hurts people in debt. If you owe interest on an account balance, as with a credit card account, the amount of interest gets added to your outstanding balance each period. So the more you owe, the more you’ll be charged in interest each year, increasing the amount that you need to pay back to the creditor.

Are Compound Interest Accounts Safe?

Many compound interest accounts are considered safe, such as high-yield savings accounts, money market accounts, and CDs. Banks guarantee your return and you do not face market losses in these accounts. Safer compound interest accounts tend to pay a lower interest rate than riskier accounts, however.

If you want to earn more, you could put your money into investments with greater risk, from mutual funds to stocks to REITs. If the investment does well over time, you can earn more yearly with compound interest. However, you also face a greater risk of losing money.

How Is Compound Interest Calculated?

Compound interest for one year is calculated by multiplying your starting amount by one plus the interest rate. If you have $1,000 and earn 5%, your growth with compound interest equals $1,000 x (1 + 5%) = $1,000 x 1.05 = $1,050. For multiple years, use this formula: starting principal x (1 + interest)^n, where n equals the number of years. In this same example, your $1,000 would turn into $1,276.28 over five years.

This formula works with annual compounding. If you compound more frequently, it gets more complicated. You could use an online compound interest calculator to determine how much you will earn over time.

The Bottom Line

Compound interest can play a crucial role in the growth of your savings and wealth over time. The earlier you start taking advantage of compound interest, the more time it has to transform your account balances. So consider it a top financial priority to research and open a compound interest account.

Article Sources
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