Are you gainfully employed? If you are one of the 30-percent of Americans that has surplus income left over after you pay your bills at the end of the month, then what will you do with the funds?
Unfortunately, we live in a spending economy where most people don’t understand the importance of saving.
Americans in their twenties and thirties may think that retirement is a long way off in the future. However, starting to save for your retirement at an early age is paramount if you want to enjoy your senior years without financial stress.
It’s a prudent financial strategy to start saving as early as you can. Your employer may already offer a 401(k) as part of your package, and it’s a viable way to start your investment portfolio for your retirement.
However, if you have surplus income, then think about opening a savings account or CD.
If you’ve never heard of these financial vehicles before, then this article will explain everything you need to know about CDs and savings.
Savings Accounts Explained
Almost all financial institutions offer savings accounts. These accounts provide a pragmatic way to save for a variety of situations. Retirement may seem like the most apparent reason for opening a savings account. However, you can use this vehicle to accumulate funds for many of life’s important purchases.
Saving for the down payment on your mortgage is an example of a prudent way to use a savings account. This strategy allows you to accumulate interest on your funds while working toward your down payment, helping you to reach your goal faster than saving cash under your mattress.
However, you can use your savings account to build funds towards remodeling your home, buying furniture, or saving for that dream vacation for you and your partner. Maybe you’re getting married and want to save for the ceremony and your honeymoon? Whatever your reason for opening a savings account, it’s the ideal way to raise funds securely.
Before opening your savings account, shop around for the best APY rates available form financial institutions offering this facility. Interest rates may vary from lender to lender, and it’s vital that you look into the APY (Annual Percentage Yield) before committing your funds.
APY is the real interest you earn on your money on an annual basis. This yield is often higher than the quoted interest rate, allowing you to benefit from the power of compound interest. In short, APY is an accurate measurement of the interest payments you earn on accrued interest, as well as the initial deposit.
The Advantages of Savings Accounts
Savings accounts have a unique set of advantages when compared to other financial vehicles like CDs.
Savings Accounts Are Convenient
It’s easy for any American of legal age to open savings accounts, and minors can do so with approval from their parents or guardian.
Log in to a financial services provider that offers savings accounts, such as a bank, and you can be the proud owner of a savings account in under a few minutes. You can also typically open savings accounts over the phone, or through a physical visit to a financial institution.
Savings accounts are easy to manage, and they let you make deposits and withdrawals without charging you unnecessary fees.
Other longer-term facilities, such as CDs, IRAs, or money market accounts charge penalties for withdrawing funds before the maturity date.
Financial institutions also allow you online access to your savings account, allowing you to transfer money in and out of the account without physically visiting the branch. You also don’t have to fill out any paperwork when transferring funds; all it takes is a click of your mouse.
Savings Accounts Are Low-Risk
A savings account is low-risk when compared to other financial vehicles available from institutions and banks. Money market accounts and IRAs have greater exposure to the financial markets, and if there is a market crash, there is a chance that you could lose a significant portion of your savings as asset prices plummet in the market.
However, savings accounts do not have this same level of risk. The FDIC, Federal Deposit Insurance Corporation, insures your deposit up to $250,000 in the case of a market crash.
The Disadvantages of Savings Accounts
Savings accounts are ideal for giving you flexibility when saving. If you have an emergency, you can dip into your savings account without accruing any penalties. However, there are some disadvantages to owning a savings account as well.
Interest Rates and Minimum Deposits
Savings accounts do pay out interest on your deposit. However, many institutions will only pay out interest on deposits over a certain amount. While lenders vary in this minimum deposit required to accrue interest payments, most of them require a minimum deposit of $2,000 to access interest payments.
While the financial institution pays you interest on your account, it may not be anywhere near the same as what you could earn with CDs or money market accounts. Most institutions offer somewhere around 5-percent for interest on your deposit. If you take your money and place it in a long-term investment instead, you could double that interest rate.
Fees Involved with Savings Accounts
Your savings account is also liable for any costs accrued. Some banks may offer a certain number of transactions per month for free, but all of them will charge you a monthly or annual fee for maintaining your account. While this fee is typically not going to drain your account dry, it adds up over the duration of a few years or a decade.
Always enquire about the costs and fees involved with maintaining your account, along with the APY you can expect from your savings.
Federal Limits on Savings Accounts
One of the best benefits of owning savings accounts is the simplicity of transferring money. However, it’s important to note that the Federal government is watching your behavior. There is legislation in place that limits the number of withdrawals permitted during a statement cycle.
The federal government does not limit how many times you deposit into the account, but it does limit your ability to withdraw. You have six withdrawals permitted per cycle, and this excludes ATM withdrawals.
In the financial world, a CD is an acronym for Certificates of Deposit. With this vehicle, you commit to depositing money with a bank or institution over a specified period. In exchange for your deposits, you receive interest on your balance.
CDs are available in a variety of fixed-terms, such as three and six months, or one, three, or five years. The longer the fixed-term, the higher the APY interest rate on your money. During the fixed term, you may not withdraw any money from the account, and if you do, then you can expect to pay hefty penalties for violating the terms of the contract.
By accumulating funds through a CD, a bank can use these funds to create other loans. Therefore, the interest you receive on a CD will always be less than the APR that the financial institution charges on other products, such as personal loans and credit cards. Through this facility, banks earn a profit on the spread between the APR they charge clients for credit, and the APY they pay you for loaning your funds.
The Advantages of CDs
There are three primary advantages of owning Certificates of Deposit. As with savings accounts, the FDIC insures your money, assuring you that the institution will always meet its financial obligations to you. As with savings accounts, FDIC insures up to $250,000 per account.
CDs also offer a far higher interest rate than you would receive through a savings account. In most cases, CDs also provide higher returns than many other investment vehicles, such as money markets accounts or funds.
It’s also possible to shop around for better rates between institutions. Smaller banks may offer higher rates to entice you to park your money with them, instead of choosing a larger, more stable financial firm. Online banks may also offer higher rates because they don’t have the same overhead costs as traditional brick-and-mortar banks.
The Disadvantages of CDs
CDs are not without their disadvantages. The primary downside of investing in CDs is that you can’t access your money for the duration of the investment term. Locking up your money for three to five years may sound great when you look at the interest rate on offer. However, if you encounter a financial emergency and need to withdraw the funds, you can expect steep penalties on your withdrawal.
Locking up your money for the long term also places you at a disadvantage if you come across other more lucrative investment opportunities. The final problem with CDs also applies to savings accounts as well – these financial vehicles do not keep up with the rising standard of living across the United States. While the Federal Reserve states that current inflation is below 2-percent, anyone who visits a grocery store can tell you how prices escalate far beyond this supposed 2-percent figure set by the Fed.
Comparing CDs vs Savings Accounts
Let’s examine the benefits and drawbacks of CDs and savings accounts. You can use this information to make an informed investment decision on which financial vehicle is right for your situation.
- Ease of Access – In this department, savings accounts are the best option for those investors that need access to liquid capital at any stage. Trying to pull your money out of a CD before the maturity date will end up costing you a significant amount in penalties.
- APY and Interest Rates – If you’re willing to lock up your money for the long term, then savings accounts can’t compare with the interest you’ll accumulate with a CD.
- Targeted Investment Goals – If you’re saving for a down payment on a home or your kid’s college education, then CDs are the best option for these long-term strategies. CDs help you to maximize earnings while incentivizing you not to draw down on your investment before it matures. Savings accounts don’t have these penalties, and it may tempt you to dip into your account for other expenses, delaying achieving your financial goals.
- Guaranteed Rates – When you deposit into a CD, the financial institution lets you known what you can expect from your return, even if it’s a five-year investment. Savings accounts may vary depending on current interest rates and market conditions that increase a banks risk of overexposure to the markets.
- Account Minimums – Some savings accounts require a minimum deposit to access interest payments from the financial institution. Therefore, you may have to reach a $2,000 minimum before the bank starts paying you anything on your deposits. CDs let you earn a calculated APY from the moment you make your deposit. Some institutions may also apply minimums to CDs as well, but its less of a common occurrence than with savings accounts, and the average minimum deposit is around $1,000.
In Closing – Use Both Savings Accounts and CDs to Grow Your Wealth
As with everything in life, the outcome of your decisions is not always black and white. Why pick between the two financial vehicles, when you can own both? By now, you should have a clear understanding of the differences between savings accounts and CDs. Use your new-found knowledge to your advantage and acquire both types of accounts.
Use CDs for your long-term financial goals, such as building the capital required for a down payment on a home. Use your savings account to save for smaller purchases, such as that dream vacation. A savings account can also be beneficial for building a fund for emergencies as well.
Both vehicles offer pragmatic ways to save your surplus income and ensure that it grows to meet your financial goals. Both CDs and savings accounts provide you a low-risk investment in your future. While investing in the stock market may yield higher returns than savings and CDs, it also does not have FDIC insurance that could save your finances in the case of a market crash.