People save money for various reasons, including purchasing a home, paying for college, renovating their kitchen, building a retirement fund, securing an emergency fund, or planning a dream vacation. Regardless of what the reason is, a savings account is a safe way to set aside cash that you don’t want to spend immediately.
Choosing the right savings account is important to maximize the hard-earned dollars you’ve stocked away. The money in your savings account can make money just hanging around, called interest. If you’re ready to put that cash in a savings account, which one do you choose? What are the benefits and drawbacks of each? It starts with education.
What’s a Savings Account?
The answer lies within the name. The purpose is to save, not spend the money you’ve gathered for a rainy day. The money in a savings account can be accessible, depending on the type of account, but the point is to keep it there, not spend it whenever you need money. A checking account and some self-control would serve you better if that’s your goal.
Just because you have extra money, doesn’t mean you have to spend it. A concept I try and teach my kids daily. It’s as if the money is burning a hole in their pockets and must be spent immediately. Teaching kids how to save is a valuable lesson they’ll take with them into adulthood.
“Is my money safe?” The answer is yes. The savings accounts discussed below are all FDIC-insured up to $250,000. If your bank goes out of business, your money is still your money. Better be, right?
A Traditional Savings Account
This is a simple concept. You put money in a bank for safekeeping and in return, the bank pays you interest on that money. That money, while in the bank’s possession, is then lent out to other people, to whom they then charge interest. Yes, you’re technically lending money to the bank with your savings account but they’re paying you to do so. Kind of a weird concept, right?
If you thought there’s a giant room with stacks of money with your name on it at the bank, you’re wrong. That money becomes someone else’s money, although you always have access to it. Every bank has different rules when it comes to opening up a savings account. This can be a fee to open the account or a certain balance to maintain the account.
How much interest does your money earn in a traditional savings account? It’s not much, but it adds up. The national average interest rate is always changing. Currently, it stands at 0.05% Annual Percentage Yield (APY), which applies to accounts with a smaller amount of money or balances larger than $100,000, referred to as a jumbo account.
While COVID has made it easier to borrow money to spend it with lower interest rates, it means your money in a savings account isn’t earning much. Can’t win, right?
A High-Yield Savings Account
Again, the name says it all. You’ll receive a higher interest rate than with a traditional savings account. What’s the catch? There’s no physical bank to walk into, but instead an online banking service. If you prefer face-to-face customer service instead of finding a human on a telephone call, this account may not be for you.
The truth is during COVID, most branches have been closed anyway and most people use their phone to bank. High-yield savings accounts are beneficial because they offer a higher interest rate, usually without a minimum balance and fees. You’re even covered by FDIC insurance mentioned above.
While there are many advantages to this type of savings account, it does have its negatives. Since there’s no brick and mortar branch, you can’t pull up to an ATM or walk into a location and establish an in-person relationship. With a higher interest rate, most people see more pros than cons.
A Certificate of Deposit Account
This type of account, also known as CDs, has the “Highest rate of return regardless of whether you invest online or at a physical bank location,” says Pocketsense.com. Sounds great, sign me up, right? Well, there’s more.
In exchange for a higher interest rate, you must leave your money until the maturity date that’s agreed upon. If you decide to liquidate your funds, you’ll have to pay a large penalty fee. Since your rates are fixed, when rates go down, you’ll be in a good position. However, if rates rise, you won’t be able to take advantage of them.
“CDs are a safer and more conservative investment than stocks and bonds, offering lower opportunity for growth, but with a non-volatile, guaranteed rate of return,” according to Investopedia.com. It can be hard not to want to spend your saved money. Is one pair of fabulous shoes going to hurt? Probably not, but who can buy just one?
Putting your money in the bank instead of a coffee tin is a start, but a CD works really well since you can’t access the funds. A coffee tin stares at you repeating over and over, “You need those shoes.”
A Money Market Deposit Account
An MMDA offers different options than the others. Similar to your checking account, you can write checks from your savings accounts, therefore making it a combination account. Investopedia.com tells us this comes in “handy if you want to receive a higher interest rate but you only need to access your funds on a limited basis.”
An MMDA is not without restrictions. Pre-COVID, the Federal Reserve Regulation D allowed for six transfers and electronic payments out of each MMDA each month. Those limits have been relaxed, giving people a chance to access their money during the pandemic. It’s recommended to check with your bank to see what the current status of REgulation D is and other transaction limits they may have in place.
There are several types of savings accounts beyond what I’ve researched above for you. Each with its pros and cons. It comes down to what you need out of your savings. Is it interest, access, protection, or something else?
As I always say, do your homework and shop around. This is your money and you have every right to know where it’s going and what you’re allowed to do with it once it has reached its destination.
That coffee can is going to become pretty full if you don’t invest the money into a savings account soon. More importantly, you won’t have the actual coffee and like money, it’s the best fuel for the day.
Here’s to the Wellness of Your Wallet!