From time to time most of us need to use savings accounts. For that reason it is a good idea to know a little bit about how they work, especially the three basic forms of savings accounts: personal savings accounts, money market accounts, and certificates of deposit (CD's).
Savings Account
Basic passbook savings accounts are the traditional accounts offered by banks, the most common and simple accounts that most people are familiar with. They have two primary benefits:
- they are simple to use—you can add or remove funds at will (almost as easy to use as a simple checking account).
- they are guaranteed by the government (Federal Deposit Insurance Cooperation).
These accounts do not produce the highest returns on investment. But if, for example, we need to make frequent deposits or withdrawals from a reserve account because of irregular fluxes in income or if we are doing short term savings for some particular project, they may be our best choice.
The Truth in Savings Act, enacted December 19, 1991, regulates how banks inform depositors about these accounts, requiring clear information about rates of interest and fees. This, together with the government guarantee of deposits, mean that savings accounts are a safe and easy account to use for even an unsophisticated saver.
Money Market Accounts
Banks also offer money market savings accounts. These accounts (also FDIC guaranteed) will offer a higher rate of return than the basic accounts but have some limitations. Typically money market savings accounts require you to maintain a minimum balance and limit how many checks or withdrawals you may make each month.
The money market savings account is also easy to use. It typically provides checks similar to a checking account, although there is ordinarily a minimum withdrawal amount and, remember, a very limited number of withdrawals per month.
Note that money market mutual funds are not the same and should not be confused with this guaranteed savings account.
A good plan may be to use a basic account for a while until you have enough reserve to be able to maintain the minimum balance in a money market account, then switch over to a money market account in order to get the higher rate of interest. Just be sure you have enough to keep above the minimum after any anticipated withdrawals because there are often monthly charges for the account in addition to losing your interest if you drop below the minimum.
Certificates of Deposit
Certificates of deposit, or CD’s as they are often referred to, are also good for savings whenever you know that you will not need the money for some set period of time. The interest rates for CD’s is usually much better but the account is less flexible.
With CD’s you deposit your money for a certain time period, perhaps a few months or perhaps a few years. The bank will offer different rates for different periods of time. CD rates are not higher or lower in proportion to the length of time but in proportion to the length of time the bank is wanting money, resulting in a strange assortment of fluctuating rates.
This means that rates will spiral up and down over time in a fashion peculiar to each lending institution. For example, if one bank has a lot of money coming in six months from now their six month rate may be high but lower right after that (knowing they won't need your money so much then) while in a bank down the street they are obligated to issue a big loan in six months and will have a different need.
Also, these offers vary greatly from week to week and from bank to bank depending on their fluctuations of available capital as unanticipated deposits or withdrawals may be made. Consequently, shopping around is essential.
Learn to Use Savings Accounts
Banks regularly offer all kinds of specialized savings accounts more as a promotional idea. Avoid being directed into a “Christmas” savings account or some other named account just because the name sounds good. Look over all the offerings with a clear focus on two items only, interest rate and fees. Pick the one that benefits you most for the use you have, not what the bank calls it.
At different times and in different places, each of these three types of savings accounts (bank savings account, money market account or certificate of deposit) may be your best choice. Know about and be prepared to use each accordingly.
