In the last couple of decades savings accounts have lost its appeal due to the minimal interest rate they are offering. Although that might not be changing drastically any time soon due to the low interest rate environment dictated by the Federal Reserve, they are still important financial vehicle and everyone should consider them for their portfolio. Today, we will discuss the importance of savings accounts, how to research available options and how to decide which one to include in your portfolio.
Looking at the framework for Goals Based Investing in our previous post Financial Planning Models we can see that savings accounts are one of the safest investments in our priority pyramid. They are very liquid assets that can be tapped quickly if resources are needed for big purchases, repairs or any emergencies. Savings accounts are usually a great option due to the lack of better similar alternatives. If you have extra cash your other options would be to leave it in your checking account, invest it in a long term financial account or maybe use it for a risky venture.
The first choice of spending it provides immediate gratification, however not the best one for a prudent financial management. If we want to be frugal we most probably want to hold on to the extra cash. Hence, the first option is to leave it in our checking account. Although this will help us have some money aside checking accounts rarely pay any interest. What is more, checking accounts usually come with a debit card that can be used anywhere and this convenience may help us spend them quickly. And last but not least if you keep your money in a checking account with no interest they will lose their value with the rate of inflation.
If you are a long term investment style person you might also consider leaving the extra cash in a stock portfolio or even increase your retirement savings. Although this may be a sound decision for some, it may not be optimal for other people. You need to consider where your emergency fund stands and whether the contributions to your retirement funds are not going to be subject to minimum withdrawals or if there are any contributions limits that may apply.
Using the money for a risky venture is always tempting as you might feel that even if you lose them you will not be in any way worse off as you didn’t have them in the first place. However, more often than not you will regret if you really lose the money and even though depending on your specific situation this can be a good choice, a much more comprehensive analysis is needed in order to make the decision.
This leaves us with the last option which is to park the money in a savings account where they will be fairly safe due to the insurance provided by the Federal Deposit Insurance Corporation. The insurance is limited to $250,000 per depositor, per insured bank for each account ownership category. Given that FDIC is backed up by the US Government these resources should be considered the riskless possible excluding end of the world scenarios.
Once we figured that a savings account is what we would like to utilize we have multiple options due to the many banks available for retail clients. Good resources for comparing different banks are the following websites:
https://www.gobankingrates.com
https://www.depositaccounts.com
https://www.monitorbankrates.com
These websites are good in organizing the current offerings of various banks and it is easy to compare them. Important factors to consider when looking at options are the following:
- APY: Annual Percentage Yield is a good indicator as to what interest the account is going to accrue for the year. Usually banks use APY to indicate what is their interest so beware if an offering is using other yield metric. Higher APY is always better
- Promotional APY period: Often Banks will try to attract more clientele by offering a higher APY for the first 6 months and then drastically reduce it. Beware of situations like these as the average annual APY might become much lower than you expect
- Minimum and Maximum deposits – depending on your specific situation these limits might be important. Regarding the maximum I wouldn’t recommend more than $250,000 in any one bank due to the loss of FDIC insurance
- Minimum Balance: Some offerings might require to have minimum balance throughout the life of the account. This limits your options in terms of withdrawals so I would be careful if you are considering such an account
- Withdrawal Limits: At the end of the day it is your money so it is a good due diligence practice to verify how often and how much you can withdraw from your account
Good luck with the choice of your Bank. We will talk more about retirement planning, CDs, and 401K accounts in the coming weeks.
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