Savings Account

Savings Account

A savings account is a bank account that pays you interest, and which you open primarily for safety and investment. It tends to be a little less convenient than a checking account.

THE DEFINITION
A bank account that accumulates interest. –Princeton University

Benefits

A savings account is a convenient, safe way to “park” money for a while—maybe years—while it actually earns more money just by sitting there.

This is what’s known as interest, which is the price paid for the use of borrowed money. The bank borrows some of the money in your savings account (and lends it out), and they’re willing to pay you for the privilege.

Another benefit of a savings account is that it can encourage you to save more money. If you make saving automatic—for example, putting a percentage of every paycheck into your account—then you make saving routine.

And pretty soon you won’t even think about the money you’re putting away, and you won’t miss it. But it’ll be working hard, earning interest for you.

Dangers?

There are really no dangers to having a savings account.

Because you’re not writing checks against a savings account, you can’t bounce a check or otherwise get into money trouble with the account. As soon as you can open a savings account, do it—and start putting money into it as soon and as often as you can.

Monday Me will thank you.

FAST FACT

Almost 70 percent of workers have saved for retirement, but many have saved less than $25,000.

How it Works

When you put money into a savings account, you and the bank make a deal. They pay you interest on your money and promise that anytime you ask them for any of that money, they’ll give it to you immediately. While your money is in the account, the bank will lend it to other customers—and charge them a higher interest rate to borrow it than they pay you. This is how banks make money. The interest paid on your savings account is a percentage of the balance in the account. If you have $1,000 in your account, and the annual interest is 5%, at the end of a year you’ll have $1,050—your original $1,000 (the principal) and $50 in interest. It’s more complicated when we use compound interest, but we’ll get to that.

QUOTABLE

You need to start, you need to be consistent with it, and you need to let the compound interest work.
– Larry Thurmond

Why a Savings Account is a Good Idea

Savings accounts are a great idea for a lot of reasons:

  • Safety
  • Convenience
  • More Saving
  • Compound Interest

Let’s look at each a little closer.

FAST FACT

17 million Americans do not have a bank account.

Safety

A savings account is safe because unlike most investments (like stock or real estate), savings accounts can’t go down in value. It’s a great tool in your money kit because it lets you earn interest from the bank with essentially no risk. Of course, the tradeoff for safety is that savings accounts often pay less in interest than you could potentially earn with other investments—the ones with higher risks.

Another layer of safety that savings accounts offer is that the safety of your money is insured. Just about any bank you open a savings account with will be insured through the Federal Deposit Insurance Corporation (FDIC). The FDIC guarantees customers’ bank accounts up to $250,000. That means that even if your bank goes out of business (pretty rare), you’ll get all your money back.

Convenience

A savings account is convenient. It gives you a quick, easy way to deposit and withdraw your money. You can do that by going into the bank, or by placing cash or checks into an envelope at a bank ATM or drive-up window. You can even have money deposited or transferred online.

A savings account is also liquid, which means you can convert it to cash very quickly. A real estate investment, by contrast, is considered illiquid, because to get your money you’d have to sell the property, which can take a long time.

With a savings account, you can walk into the bank anytime and withdraw some or all of your money on the spot.

SMART MOVE

If you use an ATM card to get money from your savings account, use your own bank’s ATM to save on fees.

More Saving

Another reason having a savings account is a good idea is that it lets you get into the money-saving habit. When you have a safe and convenient place to hold your money—a place that in fact pays you to hold it for you—you’ll find it a lot easier to start putting your money there.

Compound Interest… Wow!

Asked to name what he thought was the most powerful force in the universe, Albert Einstein reportedly answered “compound interest.”

Here’s why.

Compound interest is interest paid… on interest. Your bank will actually pay you interest on the interest they’ve already paid you. Cool, huh?

21 albert einstein

Simple Interest

There’s another kind of interest call simple interest.

Simple interest is interest paid on principal only. Earlier we explained that if you had $1,000 in a savings account earning 5%, in a year you’d have $1,050. If you were earning only simple interest—and you didn’t deposit any more money—the next year you’d earn just $50 again, because the bank would pay interest only on your $1,000 principal. When you add new principal to your account, the bank will pay interest on it, but it will not pay interest on money that you’ve earned as interest.

But what if you were earning compound interest?

Another Look at Compound Interest

Starting the first day of the next year, your new balance would be $1,050—and you’d be earning 5% on that. In other words, you’d be earning interest on the money you already earned in interest.

Over short periods of time and with small amounts of money, neither simple interest nor compound interest is going to make that much of a difference.

But….

Compare Simple vs. Compound Interest

But over the long run, compound interest is simply amazing. Imagine you make a one-time, $10,000 deposit into an account paying 10% interest, and then you just leave it there for 30 years. Look at how different the outcomes will be if your account pays…

Simple Interest: $30,000
Compound Interest: $193,582

Any savings account you open will pay compound interest, which is one reason they can be a great place to keep your cash.

Compound Interest Example

Here’s another example of the power of compound interest: You could put a few thousand dollars a year into an Individual Retirement Account (IRA) for just a few years—let’s say from when you’re 23 to 30 years old. You then leave it there and never add another dollar into it. When you’re ready to retire, your account could be worth over $1 million!

This is why compound interest is so important when you’re young: You have the advantage of time, time to let the interest work its magic. You can see for yourself how this works with any numbers you’d like.

Just Google “compound interest calculator.”

FAST FACT

Savings account transactions used to be recorded manually in a small paper notebook called a passbook, which the account holder kept.

Something Always Comes Up

In the last few years, credit card debt has jumped to its highest levels ever. Part of the reason so many people get into money trouble is that they don’t leave any money cushion for the unexpected—no savings. They’re not prepared for losing a job, an expensive car repair, or even their rent going up a few percent.

Make a habit of putting any money you can into your savings account. This will help you build a money cushion—just in case something unexpected happens. And remember: something unexpected always happens.

Be an Above-Average Saver

Experts track how much money the American people save. Can you guess what percentage of their income the average household saved in 2008? Zero. That’s 0%. The average US household’s saving rate in 2008:

Zero. Nothing. Zilch.

That means in 2008, on average, Americans spent every dollar they earned. It’s actually far worse, though, because most people spend more than they earn, which is why tens of millions of households are drowning in debt right now. If you’re an above-average saver, you’ll be able to tolerate a bump in the road AND you may find that you’re in a position to take advantage of an opportunity when others are not.

POP QUIZ

What is the biggest danger of a savings account?

QUIZ ANSWER
There really are no dangers with savings accounts.

Minimum-balance Requirements

Like checking accounts, some savings accounts require a minimum balance in the account at all times. If the amount in your savings account drops below this minimum, even for a short time, the bank will charge you a fee. These minimums are usually low—often $100 or even $25—and not all savings accounts have them. Still, it’s important to know about them before you open an account, so you never needlessly waste money in fines because you dipped below some minimum amount.

Not the Best Investment

We should point out that savings accounts generally offer relatively low interest rates compared with other, higher-risk investments.

As you get older, you’ll learn about plenty of places to invest that will generate greater amounts of money for you than a savings account. But for a safe place to keep money you can always get to when you need it—and that pays you a nice little compound-interest rate—a savings account is a valuable part of your money kit.

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