April is National Financial Literacy Month in the United States. In most cases, schools do not extensively teach financial skills. Teenagers, highly susceptible to messages from the media, often do not have guidance from teachers, who are not trained to teach financial skills, or from parents, many of whom do not model healthy financial behavior. This series of articles at Consumerism Commentary serves to help inspire discussion about basic financial concepts. Please feel free to forward this article to someone who might benefit from a basic financial overview.
This article covers the staple financial resource for anyone seeking long-term financial stability, the savings account. This is the second article in the Money Basics series; this first article covers checking accounts.
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What is a savings account?
Like a checking account, a savings account is a service offered by a bank or credit union for the purposes of keeping your money safe, secure, and accessible. While the purpose of a checking account is to allow frequent transactions, through checks, debit cards, or electronic transfers, the purpose of a savings account is long-term holding. If you have predictable income and predictable expenses, and you aim to spend less than you earn, you should be left with extra money at predictable intervals. This extra cash is the perfect candidate for deposit into a savings account.
One important aspect of savings accounts should be mentioned up front, and I emphasize this because it was never brought to my attention until I received a nasty letter of warning from a bank at which I broke this rule: you may only make up to six withdrawals per month (or statement cycle) from a savings account. If you choose to break this regulation or otherwise neglect to acknowledge it, your bank may penalize you by charging you a fee, disallowing the transaction, or even closing your account.
Savings accounts also earn interest. Every month, if you do not withdraw from your savings account, your money will grow. By giving your money to a banking institution in the form of a savings account, you are allowing that company to lend a portion your money to businesses and other individuals. Banks pay you for granting this privilege through interest payments to you.
Why do I need a savings account?
Any money that you do not need for immediate and expected expenses within one month, but that you might need in less than a year should be deposited in a savings account. This is the perfect place for a good portion of your emergency fund, money that you will use to pay your expenses if your income were to unexpectedly disappear or if an unpredictable expense were to arise.
For a suburban teenager in the United States, the first major expense might be a car. If you are like many, the first car will be purchased used (or “previously owned” as the salesmen like to euphemize). As you earn money from working during spring break or the summer, put as much from your paycheck into the savings account as possible. The more you keep in the bank, the more interest you will earn.
How do I manage my savings account?
My girlfriend has a passbook savings account. Every time she visits the bank to make a deposit, withdrawal, or transfer from or to her checking account, she hands the teller a booklet about the size of a passport. The teller uses a special printer to record the new transaction, any transactions that have not been recorded since the last printing like earned interest or ATM transactions, and the current account balance. While old-fashioned, this is a convenient way of managing a savings account. As more transactions are performed electronically or otherwise without the aid of a teller, the passbook is falling out of favor.
The popular alternative to the passbook is to receive a statement, mailed from the bank, each month. Like with the checking account, I recommend keeping your own record of every transaction that takes place within your savings account. Computer software like Quicken or Mint.com will allow you to do this, and in many cases, automatically compare what you have entered with the bank’s own records once they are available.
Almost all banks now offer online access, as well. If you ever want to check your bank balances, not trusting what you have entered in Quicken, your bank will allow you to visit a website where you may pass a security test and be granted access to view your account online.
How do I choose a savings account?
If you have previously opened a checking account, you may wish to open your first savings account at the same bank. This will allow you to perform immediate transfers from your checking account to your savings account. The benefit is your money will begin earning interest much faster than if you transferred money from one bank to another. The unfortunate down side is that most brick and mortar banks offer low rates of interest.
For this reason, I suggest opening a second savings account at a bank that offers high-yield online savings accounts. This option did not exist much more than ten years ago. A number of new online-only banks have been established since the dawn of the World Wide Web, offering great products and services with low overhead costs, creating an opportunity for them to offer better interest rates. Not to be outdone, old-fashioned brick and mortar banks are determined to compete in this new environment and have established online-only subsidiary companies or simply created savings accounts to compete with these higher interest rates.
When choosing a bank account, the interest rate offered should not be the only factor you consider, but it should be one of the most important. Look for a history of offering competitive rates as well as highly-rated customer service and an online interface with which you feel comfortable. I have reviewed the best online savings accounts, and my favorites include FNBO Direct for its consistently high interest rates and ING Direct for its above average rates and customer service record.
Once again, work to avoid fees. Some banks, particularly the antiquated branch-based banks, want you to maintain a minimum balance every month in order to avoid a monthly fee, while others don’t offer this avoidance option. These rules can get tricky. Some banks want you to have a combined balance between your checking account, savings account, and possibly even a line of credit for avoiding a fee.
Another popular fee is related to software. I mentioned Quicken above for keeping track of your savings account, but some banks will charge you a monthly fee if you connect to your bank’s electronic records directly from the program. In 2007, Wachovia charged me a surprise $5.95 for using Quicken, as I had been for several years. The bank changed their policy for some types of accounts, but the policy wasn’t intended to apply to the type of account I had. I was able to talk to a customer service representative to have the fee removed and a note placed on my account that would supposedly prevent that fee from ever being charged to me again. You might be able to talk your away out of these fees as well, but it’s better to avoid them in the first place.
When you compare interest rates between banks, you should look for the annual percentage yield (APY), not the annual percentage rate (APR) of interest. This allows a fair comparison between banks thanks to differences in compounding methods. This and more about interest will be explained in further detail later within the Money Basics series.