Banking: Savings Accounts 101
By Amy Fontinelle
After checking accounts, the next biggest thing most people think about when they think about banking is savings accounts. Having a savings account somewhere to store extra cash that you can access easily in an emergency, but not so easily (as in your checking account) that you'll spend the money on things you didn't intend to - is a key component of any good personal financial plan. While a checking account helps safeguard your money and facilitate bill paying and an investment account helps you achieve your mid-term and long-term goals, a simple savings account helps you set aside money for near-term goals like going on a vacation or establishing an emergency fund. In this section, we'll discuss the different types of savings accounts offered by banks and the pros and cons of each. (Find out how to grow your savings in Protect Your Savings From Their Greatest Threat - You.)
Regular Savings Accounts
Almost all banks offer a regular, basic savings account that you can sign up for in person, by phone or online. The difference between this account and a checking account is that it generally doesn't have check-writing privileges and it may have a higher opening deposit requirement. It may also have a higher daily minimum balance requirement. Because of banks' efforts to market their different savings vehicles, don't expect this type of account to always be called "regular savings." It may be called "statement savings," "goal savings", "day-to-day savings", or something else altogether.
A regular savings account is easy to set up and maintain. You can usually link this type of savings account directly to your checking account at the same bank and quickly and easily move money between the two accounts. Having these two accounts linked can sometimes help you avoid overdraft charges and/or under-the-minimum-balance fees from your checking account.
The main disadvantage of this type of account is its often-pitiful interest rates, such as 0.1%. If you're serious about making your money work for you, you'll probably want to minimize the amount of money you keep in a regular savings account and opt for a more powerful savings vehicle. (For more on this, see Savings Accounts Not Always The Best Place For Cash Assets.)
Online Savings Accounts
An online savings account differs from a regular savings account in that you deal with it exclusively through the internet (sometimes also by phone) and it pays interest at a higher rate. One drawback of these accounts, aside from not being able to deal with them in person through a bank teller, is that in some cases, it may take longer to get access to the money in an online savings account. For example, instead of being able to transfer money instantly between your checking and savings account, there may be a delay of several days.
Some online savings accounts are offered by the same banks that offer regular checking and savings accounts, while others are offered by banks that do not have physical branches and offer only online products. If you're comfortable with online banking, an online savings account may be a better choice for you than a regular savings account because of its greater earning potential. Many online savings accounts also do not have a minimum deposit to open an account, minimum daily balance requirements, or a monthly maintenance fee.
With some types of savings accounts, both regular and online, the rate of interest the bank will pay you depends on how much money is in your account. In these cases, customers with higher balances will earn interest at a higher rate. (Learn more about high-rate savings accounts in Handling High-Yield Savings Accounts.)
Money Market Deposit Accounts
The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is typically seen as a safe place to put money due the highly liquid nature of the securities and their short maturities. While money market investments are not without risk, money market deposit accounts are virtually risk-free because they are FDIC insured. Money market deposit accounts should not to be confused with money market mutual funds, which are offered by investment companies and are not FDIC insured.
Money market deposit accounts tend to have higher minimum balance requirements than regular or online savings accounts. This minimum usually ranges from $100 to $2,500. There may be a monthly fee associated with this type of savings account, and there is a federally imposed limit to how many withdrawals you can make per month. The interest paid will be higher than that on a regular savings account balance, but possibly less than what an online savings account would pay. Unlike many regular and online savings accounts, however, money market accounts are likely to have check-writing privileges. (To learn more, read Money Market Mutual Funds: A Better Savings Account.)
Certificates of Deposit
A certificate of deposit (CD) is a savings certificate entitling the bearer to receive interest. In many ways, it is similar to a bond, except that instead of paying interest periodically over the life of the investment, it pays all its interest at once when it matures. Also, because CDs are a bank product, they come with FDIC insurance.
A CD bears a maturity date, a specified fixed interest rate, and can be issued in any denomination. The term of a CD generally ranges from one month to five years. The amount of interest a CD pays depends on its term, with longer terms generally paying higher rates, as well as on market conditions.
In exchange for the higher interest rate you'll earn with a CD come restrictions on withdrawing your money. Taking your money out of a CD before it matures will often cost you money in the form of a penalty. (Find out everything you need to know about this investment vehicle in our Certificates of Deposit Tutorial.)
Automatic Savings Plans
Many banks offer automatic savings plans, and these can be a great way to develop a regular habit of saving money. At some banks, establishing such a plan is also a way to obtain lower banking fees.
An automatic savings plan is something you need to set up. It simply involves choosing a specific dollar amount that you're willing to have automatically transferred from your checking account to your savings account once a month, on the same day every month (except when that day falls on a weekend or holiday).
If you have an idea of how much money you generally have left over after meeting your expenses each month, you can use this as the amount that you transfer automatically to your savings account. On the other hand, you may want to allocate your extra funds to several different places each month, such as a retirement account, investment account and savings account. In this case, you'll want to choose a smaller amount. If you don't know how much money you can safely contribute to a savings account each month, creating a budget will help you figure it out.
Although some people are nervous about the idea of committing a certain amount to save automatically each month, most investment gurus say that paying yourself first is a key component of building wealth. The other major benefit of establishing an automatic savings plan is that you don't have to remember to set aside money for savings each month - it will be done for you.
While you may find that you notice the reduced amount in your checking account each month at first, after a few months you will probably get used to doing without the money and enjoy watching the balance in your savings account grow.
In the next section, we'll discuss the various ways you can keep the money in your checking and savings accounts safe.
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