A savings account is one of the simplest yet most effective tools for managing your money. It provides a safe place to store your funds while offering interest on your balance, allowing your savings to grow over time. Whether you’re building an emergency fund, saving for a big purchase, or just looking to earn a bit of extra interest, a savings account offers flexibility, security, and accessibility. In this guide, we’ll explore how savings accounts work, how to open one, and the advantages and disadvantages of using them.
What is a savings account?
A savings account is a bank or credit union account intended to keep your money safe. In most cases, they pay a small interest rate, but at least a completely safe place for the stashing of cash that one may need access to within the near future.
Some savings accounts provide higher yields than others. These might restrict the frequency of withdrawals, but in general, it's a very flexible tool to be used for building up an emergency fund, financing your car, or going on vacation—or simply gaining interest on your savings.
How does a savings account work?
Opening a savings account at a bank or credit union is very much like opening a checking account—you can do it online or in person. Some personal information will be required, and you will need to deposit some money into the account. How hard is that?
After depositing your money, it will start generating interest. How much interest you are going to earn will depend on the interest rate applicable for a savings account, APY, the amount deposited, and the tenure of the money in the bank account.
Interest could be compounding daily, monthly, quarterly, or annually, depending on how the bank has structured it. Now, how interest accrues with each period is added to your account balance at the end of every compounding period. From there, your new balance—inclusive of all deposits and interest—will now earn interest again.
Understand that APYs on savings accounts are variable and can change at any time. They are partially driven by interest rates set by the Federal Reserve. Yes, you can get your money out of a savings account any time you want, but most institutions limit the number of withdrawals to six per month.
How to maximize earnings from a savings account?
Though most of the big banks are charging very low interest rates on their savings accounts, there are ample numbers of banks and credit unions that pay significantly higher rates. Online banks, in particular, tend to offer some of the best rates since they have fewer or no physical branches, so it is their lower overhead cost that allows them to offer more competitive deposit rates.
Start by comparing rates with your checking account bank. Even if their rate on their savings accounts isn't competitive, this will give you a baseline from which to compare how much more you could earn if you move your savings or open an additional account elsewhere.
Be careful of account features that will lower or eliminate your earnings as you shop around for the best rates. Some promotional savings accounts only offer their advertised rates for a limited time. Some may cap the balance that will be eligible for the promotional rate, with higher amounts earning a much lower rate. Another thing to watch out for in a savings account is fees that can cut into your monthly interest earnings.
How to open a savings account?
Opening a savings account isn't hard if you're prepared. The following is an easy checklist for getting started:
1. Choose your application method: Determine if you are going to apply online, over the phone, in person, or by mail.
2. Gather Identification: You will need to provide your Social Security number or tax ID number and a government-issued ID like a driver's license or passport.
3. Personal Information: Be prepared to provide your personal details, for example, name, phone number, address, email address and birth date.
4. Type of Account: You may have an individual account or a joint account.
5. Terms and Conditions: Go through all the necessary documents regarding account fees and duties and how the interest is calculated before agreeing with the Bank's terms.
6. Submit your application: Apply and wait a few days for the bank to process it.
7. Fund your account: Deposit some money in your new account, ensuring the minimum balance required by most banks.
How much should you keep in your savings accounts?
This will depend on how you use the account and your financial goals.
If you set up a savings account to allow automatic transfers from checking to savings, then you can frequently expect changes in the balance. On the other hand, if you are saving to a goal, the balance will start low and then grow over time as you start building out your savings.
It's recommended that you have enough in an emergency fund to cover at least three to six months of expenses. This gives many people a financial cushion against unexpected expenses, such as medical bills, car repairs, or even loss of job.
Depending on your financial situation, you might want to keep part of your emergency fund in a no-frills savings account while investing the rest for potentially higher returns.
Be aware that $250,000 of your deposits are insured by either the FDIC or NCUA; therefore, in case of a failure, your money is totally safe. For most people this amount is sufficient. If you have over $250,000 in deposits, then you might want to spread your money over several different account holders or institutions to be fully insured.
Types of Savings Accounts
Here are the types of Savings accounts:
1. Traditional Savings Accounts
2. High-Yield Savings Accounts
3. Money Market Accounts
Click here to learn more about Money Market Accounts (MMAs).
4. Certificates of Deposit (CDs)
5. Specialty Savings Accounts
Savings account advantages and disadvantages
Advantages of Savings Accounts:
Safety and Security: Savings accounts are safe havens for money. Deposits are insured through the FDIC for banks and NCUA for credit unions, with $250,000 coverage if the institution fails.
Liquidity: Through a savings account, you can get hold of your money easily. You can withdraw the funds or move them into some other account as the need may arise, quite ideal for emergency funds and other short-term savings goals.
Interest Earnings: Although interest rates are generally small, your money can still grow in a savings account. You will earn interest without any risk.
Low Risk: It carries very minimal risk, unlike investing in stocks or any other volatile asset. This ensures that your principal amount is completely protected.
Simplicity: Savings accounts are hassle-free and easy to manage. Hence, they are suitable for people who want to save money without hassle.
Disadvantages of Savings Accounts:
Low Interest Rates: Most of the interest rates on your Savings bank accounts are lower when compared to other investment instruments, like stocks, bonds, or even CDs. That means your money may not grow that fast over time.
Inflation Risk: The low interest rates that savings accounts offer may not keep pace with inflation, which can erode the buying power of your savings over time.
Withdrawal Limits: Most savings accounts will limit the number of withdrawals or transfers you can make in any given month, usually capping them at six. If you go beyond that, it may attract some fees or have your account changed to a checking account.
Fees: Too many savings accounts include maintenance fees, minimum balance requirements, and excessive withdrawal fees, all of which begin to cannibalize the interest you've earned.
Opportunity Cost: Maintaining your money within low-yielding savings accounts may cost you the chance of making more through other alternative investments.
Bottom line
While a savings account offers a secure and accessible way to manage your funds, it may not always provide the highest returns. For those seeking to maximize their earnings, exploring options like Compound Real Estate Bonds could be worthwhile. With an 8.5% APY and features like auto-investing, these bonds offer a higher yield while maintaining flexibility and security. Balancing your savings with investments like these can help you achieve both safety and growth in your financial journey.
