Savings accounts allow you to grow your money without taking on the risks that come with stocks or mutual funds.
Setting up an automated savings program is a simple way to put money aside for an emergency fund, a down payment on a home, a dream vacation, or a future car purchase. But where should you put your money to save? There are a variety of savings vehicles to choose from, and knowing where to look for the best rates is crucial.
Savings Accounts in the Old Way
The most convenient way to save money is to open a savings account at your local bank or credit union. You can visit a local branch or use an ATM if you need to make a deposit or withdrawal. The disadvantage is that a traditional savings account may not be putting your money to the best possible use.
At brick-and-mortar banks, you can expect to earn an annual percentage yield (APY) on savings ranging from 0.01 percent to 0.30 percent. Consider putting $10,000 into a savings account with a 0.02 percent annual percentage yield. You'd have made about $2 in interest after a year.
Interest rates vary depending on the type of account and the bank, but traditional banks and credit unions typically have low rates. Banks may offer higher rates to savers with five- or six-figure savings balances.
Regular savings accounts have some advantages. They're liquid, which means you can get your money quickly. You can usually link them to your checking account to protect yourself if you make an unintentional overdraft. However, those features may not be enough to compensate for the low-interest earnings.
Important: The Federal Reserve lowered interest rates to near zero percent in March 2020. It has an impact on the interest rates that financial institutions charge on accounts.
Savings Accounts with a High Yield
High-yield savings accounts are similar to regular savings accounts, except that they pay savers a higher annual percentage yield (APY). These high-yield savings accounts are most often found at online banks, so you'll have to forego the convenience of branch banking. Higher rates, on the other hand, may be justified.
Returning to the $10,000 balance in the previous example, a 1.5 percent APY would earn you over $150 in interest, which is significantly more than traditional savings.
Of course, you must consider the issue of accessibility. If you're used to depositing cash into savings accounts, you'll need to open an account with another bank and then transfer the funds to online savings. Although a mobile check deposit can make things easier, you may have to wait a few days for the funds to clear. You also won't be able to speak to a banker or customer service representative in person if something goes wrong with your account.
Mutual Funds and Money Market Savings
A "money market" is a type of savings account that you might come across. Money market accounts are divided into two types: money market savings accounts and money market mutual funds.
Money market savings accounts function similarly to other types of savings accounts, with two exceptions. For starters, these accounts might offer higher interest rates or a tiered rate structure based on your balance. Second, they might include check-writing or debit card privileges.
Money market mutual funds are not to be confused with other types of mutual funds. A bank doesn't issue them; rather, investment firms offer them. To invest in a money market mutual fund, you can use your brokerage account or open a new account directly with the fund company. These funds pool their money and invest it in a variety of short-term investments to generate a high-interest rate.
Unlike bank money market accounts, money market mutual funds are not insured by the Federal Deposit Insurance Corporation (FDIC). Because the money in the fund is invested in the market, it carries a higher risk than money market or high-yield savings accounts. You must also consider the fees associated with money market funds, particularly the expense ratio, which is a management fee calculated as a percentage of the fund's assets. While a money market fund, such as Vanguard's Prime Money Market Fund (VMMXX), may pay a higher interest rate than savings, once fees are taken into account, you don't get to keep all of your earnings.
A certificate of deposit (CD) is another option for saving money that banks frequently offer. A CD is a time deposit, meaning the money you put on the deposit must stay there for a certain period before you can withdraw it without penalty.
A CD with a time frame as short as one month or as long as ten years can be purchased. More interest will be paid to you by the bank the longer you agree to leave your money on deposit. Banks may also give you a better rate if you keep a larger CD balance. Some banks also offer step-up rate CDs, which increase your rate regularly over the course of the CD's term.
Regarding interest rates, as of September 2020, the national average for a 12-month CD was 0.19 percent. The average savings account yielded 0.05 percent, while a five-year jumbo CD paid 0.41 percent. While CD rates are higher, the minimum deposit requirements are typically higher as well.
Because you must keep your money in the CD for a specified amount of time, it is less accessible than a savings or money market account. This can be beneficial because it encourages you to leave your money alone but can also be a hindrance in an emergency. You can get your money before the CD matures, but you'll have to pay a penalty that could effectively wipe out the interest you've earned.
Treasury Bills and Savings Bonds
The government of the United States issues savings bonds, which are backed by the government's full faith and credit. Savings bonds, like CDs, have a maturity date when the bond's value reaches its maximum. In the majority of cases, this is 20 or 30 years.
Savings bonds pay interest every month, and you can cash them in at any time, though doing so before maturity may result in a loss of interest—much like a CD. Most banks sell savings bonds, and you can also buy them online at Treasury Direct.
T-bills and notes issued by the United States Treasury are another safe investment option that can yield higher returns. Treasuries are available in various maturities, and you can start saving with as little as $100. These savings vehicles have fixed interest rates, and yields increase as the maturity term lengthens. The 10-year Treasury yield, for example, was 0.72 percent in September 2020.
Which is the best option for you?
There is no right or wrong answer when it comes to saving. In the end, it is determined by your requirements. A traditional or high-yield savings account might be the best option if you're using your savings for overdraft protection and want it available right away if you need it. A CD or money market fund will probably offer better rates if you're saving for a significant purchase or something predictable that will happen in a few months or years.
Most Commonly Asked Questions (FAQs)
Where should you put your money to save for splurging?
Capital preservation and liquidity should be your top priorities if you want to save money for impulse purchases. Traditional or high-yield savings accounts will most likely be your best bet for ensuring that the money is available when you need it.
Where can you save the most money on taxes?
Bonds are the most tax-efficient option among the options discussed here. State and local taxes are usually not applied to federal bonds. Municipal bonds may be tax-free on all levels, but they aren't typically considered safe federal bonds.