Savings Accounts: How to make them work for you!
posted
January 26, 2020
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Now that we have learned how to allocate our income into budget categories, we’re going to dive deeper into Savings. How to start and grow your account with minimal effort!
If you haven’t read our most recent blog, we encourage you to click here to learn how to use the 50/30/20 Budgeting Rule, a simple, practical rule of thumb for those who want a budget that is effective and easy to implement. As a quick recap, this rule states that your after-tax income should be roughly divided three ways:
- 50% to needs
- 30% to wants
- 20% to long-term savings
Starting a savings account can be intimidating as there are many different types of accounts out there. We’re here to help you look for some key factors and account types that can benefit you in the long run.
Interest.
For some, this word doesn’t mean much, but once you realize what interest can do for you, it will likely become a deciding factor when choosing a financial to protect your money. Earning interest is essentially making money just by having money in your account. This comes by way of a percentage of your balance, at a specific rate on a regular schedule. What you earn depends on the interest rate the financial institution pays.
Interest Rates.
When financials advertise the interest rates of their savings accounts, they state the nominal rate and the annual percentage yield (APY). The nominal, or named rate, is the rate they pay. The APY is what you earn over the course of a year, expressed as a percentage of your principal.
What you actually earn depends on whether the account pays simple or compound interest. Simple interest is calculated annually on the amount you deposit. With compound interest, which can be paid daily, monthly, or quarterly, the interest is added to your principal to form a new base on which you earn the next round of interest. For example, if you deposit $1,000 into a savings account with an annual interest rate of 5%, you’ll earn $50 that year for a total of $1,050. But if the interest compounds monthly (more on that later), you’ll actually earn about $51.16 for a total of $1,051.16, so the APY is slightly higher than the nominal rate, at 5.12%.
How can you tell whether interest is simple or compound? If the nominal rate and the APY are the same, you're earning simple interest. If the APY is higher, the interest is compound.
Money Market Accounts (MMAs).
Most financials offer hybrid accounts—part checking, part saving—called money market accounts or sometimes money market deposit accounts. They're similar to money market mutual funds, but have the advantage of FDIC insurance.
MMAs typically pay higher interest rates than regular savings accounts, and may offer blended or tiered rates, which means you can earn an even higher rate on large balances or on part of your balance over a certain level. You can also usually make a limited number of cash transfers or write a limited number of checks—generally a total of three—against your account each month.
The catch is that there are typically substantial service fees that are assessed if your account falls below the financials minimum required balance. You may also forfeit your interest if the balance drops below the minimum, or you may face both penalties.
Certificates of Deposit/Share Certificates (CDs).
CD’s are high-end savings accounts that generally pay interest at a higher rate than other bank or credit union accounts, so it should come as no surprise that there are some strings attached.
What makes CDs different from regular savings accounts is that they're time deposits. That means that when you open a CD you agree to commit your money for a specific term, or period of time. You also agree that if you withdraw money from the CD before it matures when the term ends, you'll forfeit some or all of the interest you would have earned.
Typical terms include six months, a year, two and a half years, and five years. But the term may be any period you and the financial agree on. The longer the term, the slightly higher the interest you may earn. There may be a minimum deposit—often $500—and some financials may pay slightly higher rates for large deposits.
When a CD matures, you can roll over the money into another CD, transfer your money to a different account, or have the financial send you a check. But you must tell the bank what you want it to do by the deadline it sets, or the decision will be made for you. When the financial decides, your CD is usually renewed for the same term as the expiring one at the financials current rate for a CD of that length and principal.
Interested in learning how fast your savings account can grow? Check out the calculator below brought to you by Banzai!
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