If you’re looking to build an emergency fund or save for a vacation, you may want to consider opening a savings account. A savings account allows you to stow away money while giving you access whenever you need it.
Below we’ll discuss all you need to know about a savings account. We’ll explore questions such as, what is saving, what is a savings account, how does a savings account work, and why have a savings account. You’ll gain a better understanding of the importance of a savings account and how you can use it to further your financial goals.
What is a savings account?
Exactly what is a savings account, and is it right for me? A good savings account definition would be: a type of account held in banks or credit unions that allows you to set aside money while earning interest.
Where the use of checking accounts are for frequent, daily transactions, a savings account is a way to park your money short-term. In return for stowing away your money inside a savings account, the bank will pay you a small amount of interest.
Access to your funds within a savings account is quick and easy. Most of the time, you can simply visit a bank or an ATM and withdraw your cash. There is typically a limit, however, on the number of times you can withdraw from a savings account.
A savings account is ideal for those looking to store money in a secure location while still having easy access to it. Something like an emergency fund would be a perfect reason why you’d want to open a savings account.
How does a savings account work?
Now that you have a better understanding of what is a savings account, how does it actually work? Understanding how this type of account works is relatively simple:
1. Deposit money
A savings account is a safe and secure way of storing money in a bank or credit union. One of the main benefits of this type of account is that banks insure up to $100,000 through the Federal Deposit Insurance Corporation (FDIC). In the extremely rare case that a bank goes out of business, you’ll still have access to your funds.
2. Earn interest
While your money is sitting inside a savings account, you’ll be earning interest. Generally, interest is compounded daily, and interest payouts are monthly.
Compounded interest is a powerful way to grow your money. Essentially, the bank is paying interest on the interest they’ve paid you on the previous month. This snowball effect can help grow your money rapidly, especially if you’re making additional contributions to the account.
The drawback, however, is the low-interest rates that come with savings accounts. The average interest rate is a mere 0.09% for savings accounts. Depending on the bank, you can get rates of up to 2% if you shop around.
2. Withdraw cash
As mentioned, access to your funds within a savings account can be as simple as visiting your local bank or ATM to withdraw your funds. However, there is generally a limit of six withdrawals per month. These withdrawals can be in the form of any of the following transactions:
- Debit card transactions
- Electronic funds transfers
- Overdraft transfers
- Wire transfers
Certain transactions allow you to exceed the six withdrawal limit, including:
- Withdrawing cash via ATM
- Withdrawing cash via teller (in-person)
- Transferring cash from checking to a savings account
- Requesting a check from the bank
Why have a savings account?
A savings account is a good idea for a variety of reasons. This type of account is perfect for those who need to save for the short-term while still having easy access to the funds.
Here are some of the top reasons why you should have a savings account.
1. Prevent impulse spending
With a checking account, it’s easy to spend frivolously. Simply pull out your debit card when you see something that catches your eye at the mall or shopping center.
Opening up a separate account helps curtail the temptation to spend on impulse. The transaction limits act as a barrier to withdraw cash. A savings account also helps you separate day-to-day activities from saving goals.
2. Build an emergency fund
A savings account is an ideal vehicle to build your emergency fund. Since it is easily accessible, you’re able to withdraw your cash when you most need it.
It’s also extremely secure. Your money is insured through the FDIC and is not affected by the fluctuating markets that higher risk investment accounts are susceptible to.
3. Earn interest
Situating your funds in a savings account helps grow your money through interest. While interest rates are fairly low for most savings accounts, it is better than parking money in a checking account, which typically doesn’t pay any interest.
4. Save for goals
Saving for goals such as a wedding, vacation, or a car is much easier with a savings account. Stash away a portion of your paycheck each month in a separate savings account.
A separate savings account helps you keep separate your daily transaction spending with your saving goals. Keeping track of both your savings and spending is essential to meeting your goals.
Alternatives to a savings account
A savings account is not the only way to park your money. The following list contains alternatives that you could look into. Of course, each comes with its pros and cons, so weigh them carefully against each other.
1. Money Market Accounts
Similar to a savings account, money market accounts allow you to park money into an account while earning interest at the same time. Money market accounts are FDIC insured, so they are just as secure as a savings account.
The difference between money market accounts and a savings account is you’ll typically get slightly higher interest rates with a money market account. The higher interest rate comes with more restrictions, though. Some of these restrictions may include:
- Limited withdrawal transactions
- Minimum deposit amount
- Minimum maintained balance
Failure to abide by these restrictions can result in fines or penalties.
2. High-Yield Savings Account
This type of account offers higher interest rates than the standard savings account. Where the standard savings account may pay you 0.09% in interest, a high-yield savings account can range from 1-1.35%. The higher interest rate typically comes with a minimum balance requirement for some accounts.
3. Certificate of Deposits (CDs)
Certificate of Deposits are ideal for those who do not require access to their money for at least one to two years. Withdrawal of your funds is only possible after the CDs reach the end of a fixed-term. Because of the higher barrier in accessing funds, CDs generally pay out a higher interest rate than a savings account would.
CDs come in varying lengths of terms. These terms can range anywhere from one to five years. The longer the CD term, the higher the interest rate you’ll receive.
4. Peer-to-Peer Lending
Peer-to-Peer lending is a way to lend out your money to borrowers for a specified interest rate. This interest rate is generally much higher than a savings account, with annual returns of up to 15%.
The catch is, even with qualified borrowers, there is a risk of the borrower not making payments. Peer-to-peer is not FDIC insured, so losing your money is a possibility. Liquidity is also an issue, as the length of terms generally lasts at least three years.
What you need to know about your savings account
When looking to open up a savings account, make sure you shop around. Often times, interest rates vary between different banks and credit unions. Online banks, in particular, will typically have higher rates due to lower overhead costs.
Ensure you’re reading and understanding the terms of your savings account. Along with withdrawal limits, there may be certain requirements, such as maintaining a minimum balance. Some may even have recurring fees, which can quickly eat away at your earned interest.
Consider opening a savings account at the same bank as your checking account. You’ll get the convenience of same-day transfers between the two accounts. In general, you won’t receive a savings account card by itself. A checking account with a savings account in the same bank will allow you to use one card, giving easier access to your funds in both accounts.
The purpose of savings account is primarily for short-term savings with easy access. The interest gained, however, is quite minimal. If your goal is to grow your money long-term (i.e. over ten years), treasury bills, stocks, or even bonds would be a better route to take.
Because of the liquidity of a savings account, you also require some discipline to not reach in at a whim. Savings accounts make it relatively easy to access compared to, say, stocks or bonds.
One tip if you’ve got different saving goals is to open up multiple savings accounts. Open up one for your next vacation, or upcoming home renovation, or perhaps one for your emergency fund. Having separate savings accounts helps you better keep track of your progress.
Understanding what a savings account is and its benefits can provide a safety net for you and your family.
CreditAssociates has experience helping thousands of Americans reduce debts and meet their financial goals. Whether it’s debt reduction, or simply guidance on best practices, we are here to provide aid in a friendly and confidential manner.
If you’re looking for help in achieving your financial goals, contact us today! We offer a free consultation service with our qualified Debt Consultants. Start your savings journey today!