Newbie Question: High Interest Savings Accounts

[parafly]

Hi,

I am new to the forum, and as a recent college graduate I am interested in starting to invest some of my money from my new job.

Since I do not know too much about investing and my company does not offer 401K plans until you have worked for at least 1 year, I am looking to invest in a high interest savings account until I learn more about the whole investing world out there.

I have looked at both ING Direct and HSBC Direct savings accounts, and they seem as though they would be a good starting point for me. However, I have a question about the APY rates and how they work exactly. From the research I have done, it seems as though the APY rate is the actual and real amount of interest that you earn in one year. However, when I use the calculator on the ING website, it seems as though you make less than their 3.8%.

This is starting to confuse me. Say I start with $1000 balance, and I let the account sit for an entire year. Would I be right to assume my balance after one year would be $1038 if the APY is 3.8%? Can someone please explain to me how the interest is calculated, and how much I could make in interest if I deposit about $1000 / month into the account?

Thanks in advance.

[sweeps]

First, consider opening and funding an IRA this year, since you can't participate in your company's 401(k) yet.

Regarding the APY, yes, you will have earned $38 in interest after a year on a $1,000 investment @ 3.8%. However, you will not earn $3.17 in the first month ($38 divided by 12). APY takes into account the effect of compounding, so maybe you will earn $3.12 this month, $3.13 next month, and so on until you get a total of $38 for the whole year.

[Ima saver]

As young as you are, I would suggest you fund a roth ira as soon as possible.

[goodtosave]

Originally Posted by parafly

Hi,


This is starting to confuse me. Say I start with $1000 balance, and I let the account sit for an entire year. Would I be right to assume my balance after one year would be $1038 if the APY is 3.8%? Can someone please explain to me how the interest is calculated, and how much I could make in interest if I deposit about $1000 / month into the account?

Thanks in advance.

Say you start with $1000, the interest rate is 3.74% and the APY is 3.8%.

ING compounds the interest monthly. This means that the interest earned at the end of the month is added to your balance and the bank now calculates your interest for the next month using the new balance.

After month 1, you will earn (1000 x 3.74% / 12 ) = 3.12
To be exact, you need to divide the annual interest by 365 and multiply by number of days in the month to calculate the interest earned for the past month.
New balance = 1003.12
After month 2, you will earn(1003.12 x 3.74% / 12) = 3.13

New balance = 1006.25
After month 3, you will earn(1006.25 x 3.74% / 12) = 3.14

After month 4, you will earn(1009.39 x 3.74% / 12) = 3.15

After month 5, you will earn(1012.54 x 3.74% / 12) = 3.16

After month 6, you will earn(1015.70 x 3.74% / 12) = 3.17

At the end of 12 months, you will have earned about 38.1 in interest which translates to about 3.8% APY.

Here's another website that may help. There's actually formulas that you can use to
http://banking.about.com/od/savings/a/apy.htm

Hope this helps!

[parafly]

Thank you for all of the replies. It is starting to make more sense to me now.

I have also researched some IRA investments, particularly Roth IRA because of its tax-free features. I have looked at a few websites including Vanguard. The only problem with these accounts is that there is a maximum of $4000 allowed in 1 year. This doesn't seem to be enough IMO. I would have to open several accounts, and being that I'm a newbie to investing, I don't want to go through that hassle.

I do have an additional question about the Roth IRA investments. How exactly am I earning money through these accounts? For example, if I opened a Roth IRA with Vanguard, do they take the money I deposit into the account and use it on mutual funds and other investments? Then, if the investments yield a profit, they put this profit into my Roth IRA account? What happens if they lose money on the investments?

[sweeps]

parafly, I was surprised to see you say $4,000 was not enough. Most new investors are concerned by the minimum investment. That's great. Fund the Roth to the max, and then look into other taxable investments.

Here's some good news: You can still open and fund your Roth for 2005 until April 17 (assuming you had earned income in 2005). If you do that you can effectively put $8000 in your IRA this year.

The Roth IRA is really just a "wrapper" for whatever investments you want. Usually you buy stock and bond mutual funds, but you can pretty much invest in whatever you want. The investments grow as they earn capital gains and dividends. But, as you mentioned, the investments can shrink in value as well -- that's why it's important to stay well-diversified (for example, look at Vanguard's 2035 Target Retirement Fund).