July 27, 2022

Savings Account Basics

Eric Bank
Former Citadel Director of Business Analysis

A savings account is a place to store cash and earn interest safely. Banks (online or brick & mortar), credit unions, and brokerages offer various types of savings accounts.

Types of Saving Accounts

Broadly speaking, there are four types of savings accounts:

  • Demand savings accounts: A demand savings account lets you deposit and withdraw money without penalty via an ATM or teller. Some savings accounts offer courtesy checks you can use to pay bills. You may also transfer money to another account, but you may face extra fees for more than six transfers or checks per month.
  • Interest-bearing checking accounts: Some checking accounts pay interest but usually require a hefty minimum balance. These accounts don’t limit transfer activity.
  • Certificates of deposit: A CD is similar to a short-term bond. You deposit money for a given term, typically three months to five years. The CD pays a fixed interest rate periodically and refunds your money when the term ends, although you can automatically roll the expiring CD into a new one. You can withdraw your money early but will forfeit some interest.
  • Money market accounts: These offer relatively high yields based on an underlying portfolio of short-term instruments such as Treasury bills and commercial paper. You can withdraw money on demand, but expect a high minimum balance. Brokerages offer money market funds with variable interest rates.

You can open any of these accounts by filling out the financial institution’s paperwork online, by mail, or in person. You’ll need to provide your Social Security Number to open a savings account.

Insurance

You should place savings only into an insured account. Most bank accounts are insured for up to $250,000 by the Federal Deposit Insurance Corporation. Credit unions are similarly insured by the National Credit Union Association and brokerages by the Securities Investor Protection Corporation. Bear in mind that brokerage money market funds may not guarantee that each share will always be worth $1, but this is hardly ever a problem.

Interest

A financial institution pays you interest because it lends out your money at a higher interest rate to borrowers. Some savings vehicles offer fixed interest rates, while others allow the rates to fluctuate according to market conditions. All savings accounts must post an annual percentage yield (APY) declaring how much interest they pay.

Savings accounts pay compound interest, which means one period’s interest is added to the principal amount in the next period. In other words, you earn interest on interest. High-yield accounts pay the most interest but require larger minimum balances.

Fees

Some savings accounts are free but usually require a minimum balance (typically $300 or more). Smaller accounts may charge a monthly maintenance fee, often around $5. High-yield accounts usually have higher fees and minimum balances. You may also face charges of $12 to $35 or more for excessive withdrawals, stop payments, returned items, or insufficient funds.

ATMs may charge a fee when you use them to withdraw money from a savings account. Some accounts charge for paper statements or inactivity.

When opening a savings account, try to find one with a high APY, low fees, and no transfer limits. It’s an excellent idea to sock six months of expenses into a savings account just in case of emergencies.

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