You might have heard the phrase “make your money work for you”. But what does this actually mean?
Well, the simplest and least risky way to put your money to work is with a savings account. There’s virtually no risk involved and you only need a few bucks to get started. Also, it’s way better than letting your money gather dust in a checking account or under the mattress.
What is a Savings Account?
By definition, a savings account is an account held at a bank or credit union that pays interest but cannot be used directly as money. The interest rate is fixed or variable. Interest accrues on your balance on a daily or monthly basis.
The main difference between a savings and checking account is that savings accounts pay higher interest but checking accounts let you pay for things and withdraw money. In practice, a savings account still gives you easy access to your money. To use money from your savings account, you just transfer however much money you need to your checking account. Many online banks offer free transfers between your savings and checking accounts.
A savings account is also very different from an investment account like an IRA or 529 plan.
Investment accounts involve putting money into stocks, bonds, property, or other assets. These offer the potential of far greater returns than savings accounts, but also involve way more risk.
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Pros of Opening a Savings Account
If you have spare cash lying around or the ability to deposit a fixed amount each month into your bank account, you may want to consider a savings account.
- Unlike investment accounts, savings accounts are insured by the Federal Deposit Insurance Corporation (usually for $250,000). If your bank somehow goes broke, you’re still protected.
- Although savings accounts can’t be used for withdrawals or purchases, you can still access your account at any time. Just transfer money from your savings account to your checking account whenever you need it.
- A savings account involves a stable, guaranteed income stream with virtually no risk. The worst thing that can happen with a savings account is that the bank reduces the interest rate so you earn less. But unlike an investment account, there’s no risk of negative returns (i.e. losing money).
- Stashing money in a savings account means you always have funds to draw on in the event of an emergency.
Cons of Opening a Savings Account
Naturally, there are a few drawbacks to putting money in a savings account (otherwise everyone would be doing it).
- The best savings accounts pay around 1-2% interest, which is nice but much less than you could potentially earn from riskier investments like stocks.
- Some banks charge a monthly fee for placing your money in a savings account. This can be a pain if your balance is low.
- Some banks require a minimum deposit to open an account or a minimum monthly balance to maintain an account. This is obviously a problem if you don’t have the required amount.
- Most savings accounts pay a variable interest rate, which means your rate could fall (or rise) at any time.
Types of Savings Accounts
The most basic type of savings account is what’s known simply as a savings account or savings deposit account. Beyond that, there are numerous alternative types of savings accounts.
- Deposit savings account. Also referred to as a high-yield savings account or high-interest savings account, this is just a standard savings account that pays interest. Savings accounts typically let you withdraw money at any time, but with a limit of six transactions per month.
- Jumbo savings account. This is just like a standard savings account, but for amounts greater than $100,000. In return for depositing a higher amount, jumbo accounts pay higher interest rates.
- Money market account (MMA). A money market account is like a hybrid checking-savings account. It usually comes with a higher interest rate but also a higher minimum balance requirement than a standard savings account. It typically includes features associated with checking accounts, e.g. checks, debit card.
- Certificate of deposit (CD). A CD is an account that pays a guaranteed interest rate for a fixed period. For example, a 24-month CD gives you a guaranteed interest rate for 24 months. Because a CD involves locking your money away for a fixed period, these are best used for excess cash that you don’t expect to have to use for a long time.
- Interest checking. This is technically a checking account but one that pays interest like a saving account. An interest checking account won’t pay as much as a standard savings account, but it does offer the benefit of paying a small return while also giving you maximum flexibility and unlimited transactions.
- Specialty accounts. Some banks offer special savings accounts to specific groups such as high schoolers or college students. These are like regular savings accounts but with special features, e.g. no fees or low minimum balance requirements.
Deciding Which Type of Savings Account is Best for You
Opening a savings account is the simplest way to generate money without needing to take a risk. Which savings account is best for you? The answer depends on what you are willing and able to do to get the best rate. If you’re able to deposit a large amount or lock the money away for a long time, you may qualify for a better rate. But if you only have a small amount or need easy access to the money, you may be happy settling for less. Whatever your choice, always compare a few banks and credit unions to find the best savings account for you.