CHAPTER
13

Your Savings Options

In This Chapter

  • The benefits of saving
  • Types of accounts for saving
  • The pros and cons of various accounts
  • Growing your money with interest

Saving money isn’t always easy, but it’s necessary to secure your financial future. And once you get the hang of putting away money, it’s not as hard as it might seem.

People who have some money saved tend to be less anxious than those who live paycheck to paycheck. Nearly everyone worries from time to time about how to pay the rent, or the taxes, or the cable bill. Having some money in your savings gives you a cushion if you run short of cash.

Saved money also gives you more options. That trip to Spain with some friends is possible if you’ve been careful with your spending and have some money tucked away in savings.

As your savings grow, your money can work for your future and, if applicable, the future of your family. Sending a child to college or retiring might seem like a long way off when you’re in your 20s and 30s, but years pass quickly, and saving enough for the future takes time and effort. Saving money now can ensure you’ll be able to reach your future goals.

Hopefully, you’re convinced that saving money is smart. Even a small amount every week adds up, if you know the best ways to save.

Where to Save Your Money

You have some choices about where to save your money. Sure, you can stash it in a box under your bed, but there are better options. It’s important that you find the savings account that matches your needs.

When deciding where to park your funds, consider the following:

  • When will you need the money you’re saving?
  • How accessible does your money need to be?
  • How much interest will you earn?
  • Will the account give you the services you might need?
  • What kind of penalties might you incur if you need to get your money?

The goal is to save money in an account where you’ll earn some interest but still have access to it when you need it. Let’s look at some types of available accounts and consider some of their advantages and disadvantages.

Savings Accounts

Putting your money in a savings account at a bank or credit union is reliable and safe, but you won’t get much reward for parking your hard-earned cash there. Back in the day, banks were required to pay 5 percent interest on savings accounts, but that required interest ended with banking deregulation in 1986. At the beginning of 2016, the national average for interest banks pay on savings accounts was 0.26 percent, according to MyBankTracker (mybanktracker.com), an independent resource that lets consumers compare banks.

That being said, however, it pays to shop around because the amount of interest paid varies significantly from bank to bank, and some high-yield savings accounts are available. For example, some banks were offering 0.01 percent interest on savings in February 2016, but others—mostly online banks—came in as high as 1.0 percent, with no minimum deposit. Check out MyBankTracker for a comparison of rates.

Savings accounts are safe because the money they hold is insured by the Federal Deposit Insurance Commission (FDIC). Before you open an account, though, get all the details. Ask if there are fees, such as a service fee for transactions over a certain limit. Do you have to keep a specific amount in the account to avoid fees? How will you access the money in the event that you need it? Does the bank use a tiered account system?

Pocket Change

It’s usually a good idea to have a checking account in addition to a savings account because a checking account is set up for transactions. Checking accounts also are insured by the FDIC.

Many different savings accounts are available, so take some time to look around and find one that offers some interest and has low fees. GOBankingRates (gobankingrates.com) recommends savings accounts with these institutions for 2016, considering fees, deposit rules, minimum balances, and interest rates:

Of the 10 recommended, MySavingsDirect’s MySavings Account was ranked first.

Money Market Accounts

Money market accounts (MMAs) are a type of savings account that generally pay higher interest than regular savings accounts. Most MMAs allow you to write a minimum number of checks on the account each month, usually between three and six. With some accounts, you can transfer money or access it through an ATM. As with checking accounts, some online banks offer relatively high interest rates on MMAs. Because these accounts are offered by banks, your money is insured by the FDIC.

If you write only a couple checks a month, a money market account might be worth considering. But there’s usually a hefty fee if you write more than the number of checks permitted, and the bank may require a higher minimum balance than what’s required with a savings account. And you’ll need to remember to move money from your MMA to your checking account before you need it to pay a bill. Also, some money market accounts only allow you to write a check over a certain amount. Remember that any additional interest you might earn is quickly chewed up if you have to pay for extra checks or a low-balance fee.

Pocket Change

According to Bankrate, almost half of all American bank deposits are invested in MMAs. That’s about $5 trillion sitting in these accounts.

The national average annual percentage yield (APY) for money market accounts was only 0.08 percent at the beginning of 2016, but some higher rates can be found. Learn who’s paying the best interest rates at NerdWallet’s list of best MMAs at nerdwallet.com/blog/banking/best-money-market-accounts.

Money Market Funds

Money market funds (MMFs) are different from MMAs in that they’re not offered by banks but by mutual fund families and brokerages. They’re actually a type of mutual fund, an investment vehicle you’ll learn more about in Chapter 14. MMFs are not FDIC insured or guaranteed, but most mutual fund companies try to keep them safe enough so the fund value is never a problem.

MMFs are invested only in short-term debt obligations such as certificates of deposit (CDs) and Treasury bills. A share of a money market fund usually costs $1, but the interest rates earned go up and down. Unfortunately, interest rates currently are very low, but at their height, money market funds yielded up to 12 percent. These funds are designed to keep your principal safe, so they can be a good place to park your money until you need it for something else.

Money market funds are safe choices for short-term investments. Your original investment is fairly secure while you earn a bit of interest. For example, if you invest $500 in a money market fund, you’ll get $500 back at the due date, plus a little interest. They’re not the most exciting investment vehicles, but if you have money you need to keep at a constant value, you might want to give them a look.

Pocket Change

Money market funds have been increasing in popularity, with more than $2.6 trillion invested in them in the United States.

Certificates of Deposit

CDs aren’t as widely used as they used to be because interest rates have plummeted, but they’re still worth a look for funds you know you’ll need sooner rather than later. CDs require that you deposit your money for a certain amount of time—days, months, or years, depending on the type of CD you choose. The financial institution that holds the CD agrees to pay you a certain interest rate and yield for the time it has your money.

CDs are investments for security. If you pick an insured bank or credit union, for example, your money is guaranteed to be there when the CD matures, or comes due, because it’s guaranteed by the FDIC.

The most popular CDs are the ones for 6 months or 1, 2, 3, 4, or 5 years. Normally, the longer you keep your money in a CD, the more interest you get. This increased interest rate is the financial institution’s way of rewarding you for allowing it to keep your money for that period of time.

If you don’t hold up your end of the bargain and you take your money out of the account before the specified amount of time has expired, you’ll be charged a penalty. The amount of the penalty varies by each institution, but it can be pretty hefty. If you pull out your money early, you could even end up with less money than you started with if the circumstances are right. You’d lose not only whatever interest you’d earned but part of your principal as well.

Interest rates vary, but most CDs pay a little more than savings accounts or money market accounts. Most pay fixed rates, but some offer variable rates, meaning the interest rate can change. The interest rates on CDs vary not only from bank to bank, but they also change within a bank. Rates are contingent on many factors (watch for CD specials), but they tend to mirror the interest rates in the general market. If you buy CDs with low interest rates, purchase short-term CDs and wait for rates to rise. This eliminates you tying up your funds for long periods of time.

Some banks might allow you to add money to a CD account at the interest rate of that particular day. That way, if you opened the account on a day when the rate was low, you can boost your earnings by adding money at a higher interest rate later.

Banks also may have a “bump-up” provision, which is a one-time chance to increase the interest rate on the CD.

And in today’s world of banks competing for your deposits, some banks won’t even charge a penalty for early withdrawal.

Money Pit

Some CDs advertise no penalties, but they probably have many stipulations. By law, CDs are required to charge a penalty if the money is withdrawn within the first 7 days, so there really can be no such thing as a no-penalty CD. A CD that’s advertised as having no penalty is probably a money market account in disguise.

If you’re going CD shopping, don’t just start and stop at your local bank. Check out the rates at credit unions and online at Bankrate (bankrate.com). Credit unions typically pay up to half a percentage point higher interest on CDs than banks do.

A CD isn’t the most exciting investment you’ll ever make. But if you have some money you can afford to be without for a specified period yet can’t afford to lose, it might be worth your consideration. Many different kinds of CDs exist, so do your homework before investing your money.

Treasury Bills and Treasury Notes

Treasury bills and Treasury notes, often just called treasuries, are safe savings vehicles because they’re backed by the U.S. government. The good news is that you don’t have to pay state or local taxes on treasuries, and they come in different maturity lengths.

With a Treasury bill, you buy at a discount and get the full value of the bill when it reaches maturity. You might buy a $500 treasury for $450, for instance, but when the bill matures, it will be worth the face value of $500.

Treasury notes come with maturity periods of 2, 3, 5, 7, and 10 years. You earn a certain amount of interest every 6 months you hold them. And like a Treasury bill, if you buy the note at a discount, it will be worth the face value at maturity.

You only need a minimum of $100 to buy a Treasury bill or note, so they’re an easy way to begin saving in a safe vehicle.

The Magic of Interest

It’s hard to imagine that saving small amounts of money can make a difference in your financial future, but it does. Interest, especially compound interest, can give you big returns on small investments. That’s why, regardless of how much you save, consider the interest you’ll be getting on your money.

Simple interest, which is what we normally just refer to as interest, is a method of calculating what you earn on the money you deposited or invested by applying the stated interest rate to your deposit or investment for the period of deposit. For example, if you invest $2,000 in an account for 1 year at 5 percent interest, the bank would pay you $100 at the end of the year (5% of $2,000 = $100). Not bad, huh? You get $100 just for letting your money sit there. But if you were earning compound interest on your $2,000, you’d be in even better shape.

Compound interest is paid on an initial deposit plus any accumulated interest from period to period. Compound interest gives you interest on your interest. It’s definitely the way to invest. Compounding interest at 5 percent over 1 year wouldn’t make a great difference on a $2,000 deposit, but it still would give you a couple more dollars for your money. When you get into big investments at higher interest rates, compounding interest really becomes significant.

Definition

Simple interest enables you to earn extra money on your deposit by applying the stated interest rate on only what you deposited for the exact period of deposit. Compound interest is paid on an initial deposit plus any accumulated interest from period to period.

Interest is generally compounded in one of several ways: continuously, daily, weekly, monthly, quarterly, and annually. The more often it’s compounded, the better off you’ll be.

They’re getting harder and harder to find, but look for banks that compound interest continuously or daily. When your money starts growing, you’ll be pleasantly surprised.

Sounds pretty amazing, doesn’t it? This is the power of compound interest and why a penny saved is a lot more than a penny earned.

The Least You Need to Know

  • Saving money can give you peace of mind, security for the future, and options for what you do.
  • Consider the pros and cons of various savings vehicles before you hand over money to a bank or other institution.
  • Interest rates on savings accounts, money market accounts, and CDs aren’t much to talk about these days, but it’s important to find the best rates you can, which may be from online banks.
  • When you understand interest, you can appreciate how saving even small amounts of money adds up.
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