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Savings Accounts 101

As a financial advisor, I sometimes take the simple things in finance for granted. Our topic today is savings accounts and while I tend to assume everyone knows the basics, I have found that many are confused or have questions. Two of the most popular Google searches are, “should I have a savings account?” and “how much do I need to open a savings account?”

Today, we will start with the basics, followed by current interest rates, and then end with what those values mean to you. 

Savings Accounts 101

While I use the terms savings account and money market account interchangeably, they are different. The significant difference is how the rate of return is generated. For a savings account, the bank is the one offering those interest rates. With a money market, the major difference is that the funds are invested in various types of instruments in the financial markets, and the interest rate is (usually) higher. Besides that, they are very similar in how they act. For the rest of our conversation, I will refer to them as savings accounts since that seems to be the term that most people relate with. 

The primary goal of a savings account is to provide a higher rate of return while your money sits at the bank. Most savings accounts and money markets will limit access to the funds, nothing crazy but don’t be shocked if you see something that reads, “six transactions limit per statement cycle.” They still provide check writing, ATM access, and online transfer but they limit the total. 

That is a good thing because your saving account should be a true savings account or emergency fund. In reality, you should not need access to those funds more than six times per month! If you do, then you should either keep more in checking or reevaluate your goals for the savings account. 

To answer the question of “How much do I need to open a savings account?” The answer is $1. With technology today, many banks do not require a minimum to open the account. Make sure you read the fine print though, some banks will require you to keep a minimum over time or need X number of deposits. Ally Bank Online Savings currently has no minimum balance, no monthly fees, FDIC coverage, six transactions per month and offer a 1.90% interest rate. 

FDIC Insurance

Another important topic: FDIC Insurance. Federal Deposit Insurance Corporation (FDIC) is a federal agency that insures deposits in member banks against loss if the bank holding the deposit were to fail. Now, hopefully, you never have to worry about this, but let’s not roll the dice. 

The coverage is for $250,000, per depositor, for each account ownership category. With proper planning, you can actually have coverage for more than $250,000. Each account in a single-name gets full coverage. For example, Mom, Dad, and Child open three checking accounts, each will have $250,000 in coverage. Money in joint accounts are insured separately from single accounts, so if we continue our example from above, Mom and Dad could also open a joint account for an additional $500,000 in FDIC coverage ($250,000 per depositor). 

Good news and bad news with $250,000 FDIC worries: The good news is that you have $250,000 in cash, the bad news is why do you have $250,000 in cash. 

If you do keep a lot of cash in the bank, don’t forget to do a quick FDIC check.  PRO TIP: You can also use more than one bank to increase your FDIC coverage. 

Interest Rates

This one is interesting to me. Today, many online banks offer rates that are 20x higher (Yes, 20x!) higher than brick and mortar banks. Believe me, we just switched from a very large brick and mortar bank to an online bank (see my story below). 

Most of the major banks (Chase, PNC, Wells Fargo, Bank of America, CitiBank) all offer less than .05% on their savings accounts. However, many online banks today are well over 1.0%, some are now over 2.0%!

Here is a current breakdown of a few that I saw online today (10/23/2018):

Brick & Mortar Banks

Chase Savings: 0.01%

PNC Savings: 0.01% (If you have a checking account, the rate could be as high as 0.05% or 0.10%)

Wells Fargo Way2SaveSavings: 0.01%

Online Banks

Ally Bank Savings: 1.90%

Marcus by Goldman Sachs Savings: 1.95%

CapitalOne 360 Savings: 1.00%

How Interest Rates Affect You

Hopefully, when you see 1.90% vs. .01%, you think to yourself, “Sheesh, I am missing out.” However, just to be sure, let’s put this into dollar terms. 

Assume you keep $5,000 in your savings account/emergency fund:

0.01% = $.50/year

1.90% = $95/year

Assume you keep $10,000 in your savings account/emergency fund:

0.01% = $1/year

1.90% = $190/year

Assume you keep $20,000 in your savings account/emergency fund:

0.01% = $2/year

1.90% = $380/year

I get it, an extra $94.50, $189, or $378 per year is not going to allow you to buy that island in retirement, but that is still a lot of money left on the table. And if you are going to have your money sit around, why not get paid to do so? More importantly, 0.01% does not even keep pace with inflation, so you are technically losing money each year in the form of purchasing power. Visually you are not losing money, but in the real world, you are. 

Let’s take it one step further and look the at the compounding effects over a 20-year window on the $10,000 example.

Assume you keep $10,000 in your savings account/emergency fund for 20-years:

0.01% = $10,020.02 (You earned $20.02 in 20-years with compounding interest)

1.90% = $14,570.81 (You earned $4,570.81 in 20-years with compounding interest)

Now the number is much larger when you plug in the compounding interest rate over 20-years, in this example, you would have left $4,550.79 on the table with the lower savings interest rate. 

Why You Should Have A Savings Account

Do not keep a large balance in your checking account, your checking account should be used for day-to-day transactions. Most checking accounts do not offer any interest rate, and the ones that do, provide a minimal amount. The first step is getting yourself a savings account, you can open a few if you want to use different savings buckets, for example, you can have your emergency fund bucket, travel/fun bucket, and home project bucket. Or just stick with one, and earmark certain percentages for different items, for example 50% emergency fund, 25% travel/fun and 25% home project bucket. 

Another common setback is changing bank accounts in general. You can become very attached to your banks, and they are very “sticky” once you get numerous items linked. Here’s a personal story: We just moved all of our bank accounts from our large brick & mortar bank last month. I debated this switch for a few years, but never pulled the trigger until last month. I was with this bank since I was in high school! Yet after numerous spats here and there and me realizing that I never go to the bank anymore, I decided to make the leap. It was much easier than I expected, I kept both banks open for a month or so while I linked all my autopay items to my new account, and once I saw everything was working I officially shut down the old bank accounts. It took some time and updating, but in the end, it was a needed switch.

If you don’t have a dedicated savings account, maybe now is the time to open one. If you already have one, double check your rate and see if you are leaving money on the table. 

Interest rates change often, here is an excellent (updated monthly) resource from Bank Rate that shows the best rates currently: Best Savings Accounts & Rates – October 2018

Written by Chad Chubb, CFP® 

Disclosures: Entities mentioned in this content are provided for informational purposes only and does not reflect a recommendation or endorsement.