While most people say that earning money is a challenge, it’s deciding what to do with that money that becomes an even greater challenge.
Managing your money requires asking questions and then making financially wise decisions. One of those questions is deciding where to put the extra money that you have. Sounds simple, right? It can actually be complex.
Here’s what I mean: let’s say you have extra cash that you don’t want to sit in a checking account receiving no interest, but at the same time you don’t want it locked away in a hard to access fund.
That’s where savings accounts come into play. But there are several types of savings accounts, along with differences to know before choosing and opening an account.
Read further to learn which type of savings account would best fit your financial needs.
What is a Savings Account?
Before you can start using one of many types of savings accounts, it’s important to understand what a savings account is.
Savings accounts are vehicles for reaching short term saving goals. They are bank accounts designed to help you set extra money aside while maintaining a balance of accessibility: it takes an extra step or two to access it, which makes it easier to avoid unnecessary, spur of the moment spending. At the same time, the money is accessible in the event that you need it.
Banks offer features like automatic transfers back and forth between a savings account and a checking account to help you in this process of putting money away and accessing it when necessary.
Banks also pay interest on the money you deposit into the account. Interest is money that the bank pays you in exchange for holding your money — something that is not offered with checking accounts.
Banks use the funds deposited to savings accounts to fund other activities, such as lending, so they earn a profit using your money. The interest they pay to you is your cut of that profit. We’ll break down how much interest you can make in a savings account later on in the article.
Keeping your extra money out of your checking account and in a savings account has benefits beyond the interest that you’ll earn, too.
You can open a savings account at nearly any bank, whether it’s a brick and mortar bank or online. All you have to do is choose from one of the many types of savings accounts that you want and fund the account.
Types of Savings Accounts
There are four different types of savings accounts that you can choose from:
- Basic Savings Account
- Online Savings Account
- Money Market Account
- Certificate of Deposit (CD)
Each account has its benefits, drawbacks, and characteristics that make it ideal for different saving goals.
Basic Savings Account
Almost every brick and mortar bank that you can find offers basic savings accounts. If you already have a checking account, you can likely open a savings account with the same bank and transfer between the two accounts.
That makes managing your money more straightforward — and less of a chance of occurring multiple fees — than if you had accounts at multiple banks.
While each bank’s savings account will have unique characteristics, there are a few generalities.
One is that while basic savings accounts offer interest, they aren’t significant today.
You’ll be lucky to find an account that pays more than .05 percent or .1 percent interest. That means that for every $1,000 that you deposit, you’ll earn just 50 cents or $1.
Something else to factor in is how inflation affects this already low-interest rate.
Since 2016, inflation in the US has hovered around 2%, so the truth is that you’re actually losing spending power by keeping money in a saving account for a prolonged period of time. Thus, whatever you earn will be eaten away by inflation.
Because of this, don’t let your cash sit in a savings account for a prolonged period of time! It’s wise to invest money that you don’t plan on touching in the near future, where you can see much higher interest rates.
But, for savings that you do plan on using, savings account offer at least some interest, which is more than a basic checking account.
Having your savings account at a local brick and mortar bank also makes it easy to access, something that you can’t do with an online savings account.
Online Savings Account
Online savings accounts are one of the types of savings accounts offered by online banks, which of course don’t have a physical location.
They offer higher interest rates than basic savings accounts offered by traditional banks — some accounts pay up to 2 percent interest.
They also have fewer fees and lower minimum balance requirements. Be sure that you read any applicable fees because some banks will make you pay a fee of $5 — $10 or more every month unless you have a certain amount of money with the bank.
Another note to remember is that putting your money at an online bank rather than a traditional bank makes it harder to access, which can be a double-edged sword.
Making your money harder to access helps reduce the temptation to spend. However, it also makes it harder to get your money if you need to make a quick withdrawal — this process can often take days, and you are limited to the number of times you can make a withdrawal.
Money Market Accounts
Money market accounts, another option to consider when thinking about types of savings accounts, aim to combine the benefits of savings accounts and checking accounts but do so at a high cost.
Like online savings accounts, they offer higher rates of interest on the money you deposit — you can find accounts that pay 2 percent interest or potentially more. Like checking accounts, you’ll receive a checkbook and a debit card that you can use to make purchases.
Money market accounts are designed for those who need the flexibility of the combined features of checking and savings accounts. They have high minimum balance requirements, usually in the thousands of dollars, and charge hefty monthly fees if you don’t meet the waiver requirements.
You are also limited in the number of transactions you can make when using a money market account. In most cases, if you make more than six transactions in a month, other than in-person or ATM transactions, you’ll pay an excessive transaction fee of $5 — $10, which although may seem small, can add up over time.
These factors are why we recommend that you avoid money market accounts. But it’s still important to understand what they are so that you’re not swayed into a decision that you may not fully understand.
Certificates of Deposit (CDs)
Certificates of Deposit offer the highest interest rate of all the types of savings accounts — up to 2.5 percent — but you sacrifice significant flexibility for the increased earnings.
When you open a CD, you are essentially promising to keep your money in the account for a certain period of time. This could be as short as 3 months or as long as 10 years.
The period of time that you wind up choosing is called the CD’s term. You are not allowed to make withdrawals from your CD until its term ends, and if you make an early withdrawal, you’ll pay a penalty fee. Plus, the longer the term of your CD, the larger the fee will be.
Early withdrawal fees are calculated based on the amount of interest you earn in a day. For example, you could pay a fee of 180 days’ interest if you make an early withdrawal from a 1-year CD.
CDs rarely have monthly fees, but many have high minimum deposit requirements, ranging from $500 to $2,500 or more.
Many banks offer CDs, including both traditional and online banks. But the truth is that you can receive much better interest in other investment opportunities, which we’ll detail further on in the article.
Are Savings Accounts Safe?
When you’re saving money, you want to feel confident that your money will be taken care of.
One of the benefits of savings accounts is that they are among the safest places to put your money. It’s almost impossible to lose money that you deposit to a savings account.
Here’s how: the Federal Deposit Insurance Corporation was created to ensure that savings accounts are as safe as possible.
They provide insurance for up to $250,000, per account type, per depositor at banks in the United States. That means that you can put as much as that amount in a savings account and have it completely insured.
If a bank fails, the FDIC steps in to make sure that the bank’s customers do not lose money. If the bank is unable to return the money that you deposited, the FDIC will reimburse you for the full amount lost, up to its $250,000 limit.
The FDIC’s protection is “backed by the full faith and credit of the U.S. government,” making it one of the strongest protections available.
However, the FDIC can’t protect you from inflation eating away at your savings.
Because savings accounts pay so little interest, your money won’t grow. Depending on inflation, you might even lose spending power by keeping your money in the account.
In this sense, saving accounts are too safe.
How Much Should You Be Saving?
Once you choose one of the types of savings accounts and you’ve opened one, it’s time to start strategically saving.
But before you start, you have to figure out how much you should save each month. More so, ask yourself the following: what are my financial goals for saving? Is it to build up your emergency fund, get out of debt, or start your own business?
Take a minute to jot down a few goals, but don’t stop there. After all, a goal without a plan is just a wish. Once you know your goals, make a plan.
Divide the amount you need by the number of months between now and the date when you’ll make the purchase. The resulting number is the amount that you have to save each month.
Once you know why you’re saving, the tools that are available to help you do that, and your plan, reaching your financial goals will only be a matter of time.
TJ Porter is a Boston-based freelance writer who specializes in credit, credit cards, and bank accounts.