Money that is considered savings is often put into a low risk, interest-earning account, rather than into higher risk investments. Although there is opportunity for larger returns with certain investments, the idea behind savings is to allow the money to grow slowly with little or no associated risk. The advent of online banking has increased the variety and accessibility of savings accounts and vehicles. Here are some of the different types of accounts so you can make the most of your savings.
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- Savings Accounts
Savings accounts are offered by banks and credit unions. The money in a savings account is insured by the Federal Deposit Insurance Corporation (FDIC) up to specified limits. Certain restrictions may apply to savings accounts; for example, a service fee may be charged if more than the permitted number of monthly transactions occurs.
Money in a savings account typically cannot be accessed through check-writing or ATMs. Interest rates for savings accounts are characteristically low; however, online banking does provide higher-yielding savings accounts. (Even with inflation fears, saving money is still sage advice in a recovering economy. Check out How Savings Are Saving The Economy.)
- High-Yield Bank Accounts
High-yield bank accounts are a type of savings account, complete with FDIC protection, which earns a higher interest rate than a standard savings account. The reason that it earns more money is that it usually requires a larger initial deposit, and the access to the account is limited. Many banks offer this account type to valued customers who already have other accounts with the bank. Online high-yield bank accounts are available, but you will need to set up transfers from another bank to deposit or withdraw funds from the online bank.
- Certificates of Deposit (CDs)
Certificate of Deposits (CDs) are available through most banks and credit unions. Like savings accounts, CDs are FDIC insured, but they generally offer a higher interest rate, especially with larger and/or longer deposits. The catch with a CD is that you will have to keep the money in the CD for a specified amount of time; otherwise, a penalty, such as three months' interest, will be assessed.
Popular CD maturity periods are six-month, 1-year and 5-year. Any earned interest can be added to the CD if and when the CD matures and is renewed. (A CD ladder allows you to stagger your investments and take advantage of higher interest rates. Learn how in Save Smart With A CD Ladder.)
- Money Market Funds
A money market fund is a type of mutual fund that invests only in low-risk securities. As a result, money market funds are considered one of the lowest risk types of funds. Money market funds typically provide a return similar to short-term interest rates. Money market funds are not FDIC insured, and are regulated by the Securities and Exchange Commission's (SEC) Investment Company Act of 1940.
Mutual funds, brokerage firms and many banks offer money market funds. Interest rates are not guaranteed so a bit of research can help find a money market fund that has a history of good performance.
- Money Market Deposit Accounts
Money market deposit accounts are offered by banks, and typically require a minimum initial deposit and balance, with a limited number of monthly transactions. Unlike money market funds, money market deposit accounts are FDIC insured. Penalties may be assessed if the required minimum balance is not maintained, or if the maximum number of monthly transactions is surpassed. The accounts typically offer lower interest rates than certificates of deposit, but the cash is more accessible. (Learn more about liquidity in Diving In To Financial Liquidity.)
- Treasury Bills and Notes
U.S. government bills or notes, often referred to as treasuries, are backed by the full faith and credit of the U.S. government, making them one of the safest investments in the world. Treasuries are exempt from state and local taxes, and are available in different maturity lengths. Bills are sold at a discount; when the bill matures, it will be worth its full face value. The difference between the purchase price and the face value is the interest. For example, a $1,000 bill might be purchased for $990; at maturity, it will be worth the full $1000.
Treasury notes, on the other hand, are issued with maturities of 2, 3, 5, 7 and 10 years, and earn a fixed-rate of interest every six months. In addition to interest, if purchased at a discount, T-notes can be cashed in for the face value at maturity. Both Treasury bills and notes are available at a minimum purchase of $100.
A bond is a low-risk debt investment, similar to an I.O.U., which is issued by companies, municipalities, states and governments to fund projects. When you purchase a bond, you are lending money to one of these entities (known as the issuer). In exchange for the "loan", the bond issuer pays interest for the life of the bond, and returns the face value of the bond at maturity. Bonds are issued for a specific period at a fixed interest rate.
Each of these bond types involves varying degrees of risk, as well as returns and maturity periods. In addition, penalties may be assessed for early withdrawal, commissions may be required, and depending on the type of bond, may carry additional risk, as with corporate bonds where a company could go bankrupt. (Raters have, in the past, been a reliable source. Are those days over? Find out more in Bond Raters On The Rocks.)
The Bottom Line
Savings allow individuals to squirrel away money while earning modest, low-risk returns. Due to the large variety of savings vehicles, a little research can go a long way in determining which will work hardest for you. And, since interest rates are constantly changing, it is important to do your homework before committing your money to a particular savings account, helping you make the most of your savings.
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