When people talk about having money for a rainy day they are usually referring to putting their money into a savings account. A rainy day or emergency fund is used to set aside money from every paycheck so that in the event of an emergency or unexpected expense thereâs money readily available. Using a savings account to pay emergency bills, save up for vacations, put aside money for holidays, and have cash available to buy birthday gifts means that you do not need to use credit. When you avoid credit, you avoid the ongoing burden of paying interest or possibly hurting your credit score.
Not all methods of saving are created equal. There are three basic kinds of savings vehicles consumers can use: savings accounts, certificates of deposit, and money market accounts. Each of these methods for saving money has their pros and cons that every consumer should be aware of. If you’re a conservative investor looking for something more than saving a little money, be sure to check out my piece on conservative investing instead.
The simplest and easiest way to get started saving money is by way of a savings account. These are relatively easy to sign up for and most banks simply require a small initial deposit to start an account. Most people get a savings account at the bank in conjunction with the checking account they use to pay their bills and other expenses.
The money in a savings account accrues interest as long as it is in the account. That means that the money you have been saving all year for Christmas presents will grow with interest. Savings accounts are also very easy to use. You can do transactions at your local bank branch, on the internet with your online banking account, or you can use an ATM card at virtually any machine.
One of the drawbacks of a savings account is that many local banks donât offer the best account features. Some banks will only allow a certain amount of ATM withdraws for free before charging a fee, some require a minimum balance to avoid a monthly fee, and interest rates are often very low. So, while opening a savings account tied to your checking account at your bank might be the easiest way to go, it may not be the best.
Instead youâll probably want to explore online savings accounts. Just like your traditional savings account at the local bank, online banks can provide much better rates and features because they donât have the high overhead of staffing physical bank branches. In fact, these banks often have interest rates ten times higher than most brick and mortar banks. Learn more about your online savings account options here.
Certificates of Deposit (CD)
A CD can be a savings vehicle but it acts a little bit more like an investment. You deposit your money into a CD and then keep it there for a predetermined period of time, usually ranging from a few months to a few years. Because you are telling the bank you expect to leave the money in the account for a set amount of time CDs typically pay higher interest rates than a regular bank account. And the longer you agree to leave the money on deposit, the higher the rate.
Unfortunately, this can come at a cost if you decide you need to withdraw the money early. Typically you will pay a small penalty in the way of forfeited interest if you choose to cash out the CD before the term expires. While it isnât a stiff penalty, it usually wipes out any of the added benefit you received by going with a CD in the first place, so money deposited here should be money youâre fairly certain you wonât need before the term is up.
Using a CD is a smart way to turn money you know you wonât be spending for a while into a little extra interest, but may not be the best place for an emergency fund where the need for that money could arise at any time. Instead, consider CDs for predetermined future uses such as a down payment on a house, buying a new car, or family vacation.
Money Market Accounts
Money market accounts offer some of the best of both worlds as they usually offer higher interest rates with penalty-free access to your money. The initial buy-in on a money market account is often Â higher that a savings account or certificate of deposit, but the interest rates are also typically better that the other forms of savings accounts.
Money market accounts allow customers to withdraw money or write checks from the accounts up to a limit of six transactions a month. The higher interest rate means that money market accounts can sometimes be a better savings option than savings accounts for people that want to save larger sums of money.
A money market account is not the ideal solution for someone who wants a savings account with a low balance and easy access. The fees for allowing a money market account to dip below its minimum balance requirement can be very high and the minimum balance required can range from $1,000 up to the tens of thousands of dollars. The limitation on the number of monthly transactions makes a money market account slightly less convenient than a savings account.
Finally, thereâs one more method of saving available to most people, but many consider it a bit old fashioned. Savings bonds have been around for ages, and in the past it was a very safe way to save money. Today, with the wide availability of banking institutions, FDIC insurance, and access to the internet, savings bonds arenât as common, but they still provide a way to save. You can learn more about bonds and check out interest rates at the Treasury Direct.
Bonds typically behave more like CDs than a savings account. You are usually required to hold the bond for a certain amount of time before cashing it out, and if you cash it out early youâre subject to a small penalty. There are two primary types of bonds for you to choose fromâ’one that is tied to inflation and one that isnât. Rates change with economic conditions so youâll obviously want to check to see what interest rates are before buying a bond.
Again, if liquidity is more of a concern to you, a high-yield savings account or money market account is likely going to be your best bet. But if youâre putting money aside specifically for a distant event or purchase, then a CD or savings bond may be the better option depending on the interest rate environment.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.