Once upon a time, the only type of savings account commonly offered was a passbook account. You were given a little book that you brought to the bank with your deposits, and each record was stamped into this passbook, both deposits and withdrawals, always including a total balance in the account.
Today, there are many different types of savings accounts that are offered to help you save. In order to choose the ones that are right for you and your personal financial goals and situation, you need to be aware of all the choices.
Instant Access Savings
Instant access savings accounts, also commonly called regular savings accounts, are accounts that allow you to have ready access to the funds in the account. This type of savings account pays the lowest amount of interest but does allow you to get to your money should you need to at any time.
These accounts can even be part of your ATM card, allowing withdrawals 24 hours a day, 365 days per year. The minimum amount required to open this type of savings account is usually very low. Some banks offer this type of savings with an initial deposit of only $50 or $100.
The interest rate paid to the account holder on this type of savings account fluctuates as the economy changes and can go up or down. Some of these accounts have daily interest compounding, while others compound monthly or even yearly.
Use this type of savings account only for an emergency fund or as a holding place to save up enough money to move into a better type of savings or investment. You should avoid placing the bulk of your savings into this type of account for two major reasons:
The interest rate is lower than other types of savings accounts or investments.
Ready access allows you to spend the money without giving careful forethought to your expenditure.
However, this type of account is great to have on hand for holding the equivalent of one month’s salary as an emergency fund. Once you build your balance to higher levels, move the excess money into a better form of savings that pays a higher interest rate.
These accounts, when opened with a banking institution, are insured by the Federal Insurance Deposit Corporation up to $250,000 per person. This means that should the bank go bankrupt for any reason, such as those which resulted from the 1929 stock market crash, the United States government insures your money will be paid to you.
Many banking institutions offer an automatic transfer from your checking account each month to help you save money without thinking about it. However, you must be certain the funds are in your checking account at the time of the transfer, so be sure this option is for you before establishing an automatic transfer. Overdraft fees may apply if the funds are not available for transfer on the pre-set date.
Money Market Savings Accounts
Money market savings accounts are a way to get a higher interest rate than regular, instant access savings, but still maintain easy access to your funds. With this type of savings, the banking institution invests the money placed in their trust in secure investments, allowing them to pay a higher return.
Usually, money market accounts require a minimum initial deposit to open that is much higher than an instant access savings account, often $1,000. Interest earnings may be even higher for larger balances.
Often, banks offer the money market account holder the right to write a limited number of checks on this type of account each month without penalty, but this varies greatly from institution to institution. You must be sure to fully understand the policies of any bank with which you are considering opening this type of account.
Money market savings can be a good next step up from regular savings once you have built a balance greater than the minimum required for the minimum to open a money market account. These accounts are also insured by the FDIC when the funds are held by a bank.
Investment firms also offer money market accounts which are not insured by the FDIC and therefore may have some risk.
Short-Term Certificates of Deposit
Certificates of deposit (CDs) are a type of savings where you deposit a sum of money with a bank for a specified period of time at a set interest rate. Short-term CDs usually are considered to be a deposit length of one year or less. If money is removed from this type of account before the date of maturity, the payoff date of the CD, a substantial penalty in the earned interest must be paid.
CDs that mature in as little as one month can be found, but most short-term certificates of deposit are based on a three-month, six-month, or one-year maturity. On or after the date of maturity, the money can be removed from the CD without penalty.
You can also arrange for automatic rollover, which means that if you do not notify the bank you want the money removed from the CD within a specific number of days before or after maturity, the money automatically will be invested in another CD of the same type.
Certificate of deposit accounts usually require a larger initial deposit amount than other saving vehicles, but you may find that your local banking institution offers short-term CDs for as little as $1,000. Some other banking institutions require a minimum of $5,000 or more for an initial deposit.
The short-term CD is a good way to earn a higher, defined interest rate on savings that you might need to have access to in the near future without penalty. Just be certain that you can leave the money in the CD until it matures, or the penalty for early withdrawal could result in your earning even less return than if the money had been held in a money market account.
A good strategy is to purchase multiple CDs that mature on different dates, perhaps one month apart, so that you can gain access to funds reasonably often should the need arise.
Long-Term Certificates of Deposit
Long-term certificates of deposit are those that require your money to remain in the interest-bearing account for a predefined period that is longer than one year. These also earn a defined rate of interest over the life of the CD, compounded as defined by the account terms.
The rate of interest is higher than for short-term CDs, and with larger CDs the interest rate can be quite good. The interest rate on this type of investment vehicle will not adjust should the average rate of interest being paid on other accounts increase — but it will not decrease should the average rate of interest go down.
These CDs offer secure savings when purchased through a banking institution because they are FDIC insured. You know exactly how much the CD will grow over its life and what amount will be paid to you at maturity.
If purchased during a period of high interest rates, this can be a good vehicle for saving for retirement, college for the children, or for a family legacy. You must be certain that the money will not be required during the entire life of the CD, which can be as long as 20 years, or you will have to pay a steep penalty, negating the higher interest rate.
Again, this type of CD can be great if you purchase several that mature on different dates, allowing your money to be available at staggered dates.
No-Risk Certificates of Deposit
A newer type of certificate of deposit that is being offered by some banking institutions is the no-risk CD. These require a large initial deposit in most cases, but after a short period of time, money can be withdrawn without penalty.
The interest rate on these CDs can fluctuate up or down. The basic idea behind the no-risk CD is that the instrument actually is a short-term deposit that automatically rolls over without your having to do anything. These certificates, like all bank-issued CDs, are FDIC insured.
Laddering Certificates of Deposit
One way to effectively use certificates of deposit to your benefit is with what is known as “laddering.” CD laddering applies the strategy of purchasing CDs of various amounts with varying maturity dates. This strategy allows you access to money within a short period of time without penalty, since at least one of your CDs purchased is set up to mature soon.
Most people who elect to use CD laddering invest in several smaller, short-term CDs that mature at monthly or quarterly periods, and invest in several longer term CDs that mature at varying periods such as every three to six months.
If you choose to invest a part of your personal savings in CDs, this strategy makes it both practical and a way to take advantage of rising interest rates. When each CD matures, you have the choice to renew it at the then-current rate. However, if interest rates have gone down, the current rate at maturity is the rate that will be offered to you for renewal.
Tags: automatic transfer, certificates of deposit, interest rates, money market, no-risk CD, PERSONAL FINANCE, savings