How to Open a Compound Interest Account,Learn what compound interest is, and how to open an account.
Compound interest is when you earn an interest return on your savings, which you reinvest to grow even more. In other words, you earn interest on your interest. As you build your savings from past interest, you receive a higher return each following year 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
A compound interest account is any account that lets you earn interest or some other return to grow your savings. You could open a compound interest account with a bank, or you could also open a compound interest account with an investment broker.
Here’s how it’s done.
Steps Required to Open a Compound Interest Account
Each company has its specific process for how to open a savings account with 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? You may be better off with 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? Then you would want a brokerage account to invest in bonds, mutual funds, REITs, and stocks. You may find a company that gives you a combination of both. For example, Fidelity allows you to invest in the market while also paying a guaranteed interest rate on your uninvested cash.2
Step 2: Compare costs, fees, and incentives. Each compound interest account has its own set of costs and fees. Some fees you could run into include:
- Annual account fees: A compound interest account could charge a flat fee annually.3
- Minimum account balance fees: Financial institutions often charge a monthly fee if your balance isn’t large enough. For example, you need at least $500 in your account, or you owe this fee.4
- Trading commissions: Investment brokers could charge a commission every time you buy and sell assets for 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 less you earn overall. The best compound interest accounts keep these as low as possible. Companies may also offer incentives when you open a new compound interest account. For example, you receive a $200 bonus for opening a savings account. Check for these as well to get a jump start on growth.
Step 3: Compare services. Not every company offers the same services. Think of what you’d like from your compound interest account in these categories:
- Product selection: There are many ways to earn compound interest. Each financial institution provides a different product selection. Consider how you want to save or invest and ensure the option is available.
- Access to a variety of investment accounts: You could earn compound interest through a regular bank account or 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 are available.
- 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 plan your budget or see if you’re on track for retirement. Some provide extensive educational materials.
- Access to brick-and-mortar branches: Do you want to get help in person, or are you OK handling everything remotely? Some compound interest accounts offer brick-and-mortar branches, while others do not.
- Customer service options: Companies have different service options like phone, email, and live chat. They also have different service hours. See that a company offers what you want.
- Support from a financial advisor: If you’d like support from a 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.5
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.6 Brokerage investment accounts can take as long as several days, as the broker must review your application and financial information.5
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.
What You Need to Open a Compound Interest Account
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 meet other government regulations (like anti-money laundering.) So expect to provide the following.
- 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 another 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 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:7
- Employment status and occupation
- Annual income
- Net worth
- Risk tolerance for losing money
- Investment goals and objectives
Understand the Basics
If you’d like to start earning compound interest, you need to decide on the type of account. There’s a broad range of compound interest accounts. You can choose from very safe, basic accounts that take very little research. You could also focus on more complicated, higher-risk accounts with higher possible returns. Here are the more basic, safe 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 highly competitive return with very low fees; most are free. You can’t lose money in a savings account, and savings accounts give you convenient access to your money at any time. If you’d like to learn more about high 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 owe a monthly fee. In exchange, money market accounts usually pay a higher interest rate. 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 whenever you want.
Certificates of Deposit (CDs)
When you sign up for a CD, you pick how long it will last (the term). 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 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 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. During this period, you receive interest, and you get your money 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 checking the issuer’s credit rating. If a bond issuer runs into financial trouble, it might not pay all the interest or even fail to pay you your deposit back. To stay safe, 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 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.8 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 so you can earn compound interest this way.
Mutual funds combine the money of many small investors to create a large investment portfolio. A professional investor manages the portfolio to decide on the investments. Each mutual fund has different investment objectives. For example, an income mutual fund would focus on bonds and other safer investments, while a growth mutual fund would focus on higher-risk but higher-earning investments like stocks.
There is more risk with mutual funds. The investments may not work out, and your balance could fall. However, mutual funds have higher earning potential than bank accounts. If you’re investing long-term, you could potentially earn more compound interest using mutual funds.
Types of High-Risk Compound Interest Accounts
These compound interest investments can earn more than the basic options if you want to push for a higher return. But, be warned, they also require more research and you have a higher risk of losing money.
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 build a portfolio of properties. You earn a share of the profits from rent and property sales. It’s a way to make compound interest from real estate without going through the work and high 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.9
With bonds, generally, the riskier the investment, the higher the interest rate. High-yield bonds, or junk bonds, pay a higher face interest rate. As a result, you earn more in compound interest. However, high-yield bonds have an increased risk of default. 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.10
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.11 Cryptocurrencies are another very high-risk, potentially high-reward investment.
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 to continue growing or pay out earnings to shareholders through a dividend payment. Dividend stocks come from companies paying a higher dividend rate. 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. Confirm that a company will remain profitable so it will keep paying. For 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 dividends.
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. Some, like hedge funds, require you to be an accredited investor. In exchange, these investments could also earn high returns.
Compounding frequency is how soon 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 wondering how to open a daily compound interest account, our review of the best CD rates identified many that do just that.
If you owe fees for your compound interest account, they will be deducted from your balance. Therefore, the more you pay out in fees, the less you keep for your annual interest earnings for compounding.