Comprehensive Guide to Savings Accounts, Money Market Accounts and Certificates of Deposit
January 29, 2009
After years of depositing very little cash into traditional savings accounts, more Americans are reconsidering the stable investment options at their local banks. They are saving money, either to hide from a risky stock market or to prepare for tough financial times. Meanwhile, tighter lending guidelines have forced banks to refocus on their deposit businesses. Both trends have created unusual opportunities for savers.
Still, it can be confusing for many Americans to choose the right savings accounts for their needs. Picking the wrong kind of account can lead to hefty fees or lackluster dividends. By understanding how you intend to use your money and how you prefer to do business, you can find the best options for your own cash stash.
Savings Accounts: Lower Interest, Higher Flexibility
For most of us, our very first trip to the bank involved a passbook savings account. Many Americans still think basic savings accounts are kid stuff, offering meager returns and limited access to funds. However, the banking industry has leveraged technology to make simple savings accounts sexy again. At a handful of banks, savings rates rival CD rates without the typical restrictions on deposit length and minimum investment.
High yield savings accounts appeal to customers who:
- Like to handle their banking online,
- Have less than $250,000 to invest,
- Must open their accounts with under $2,500, and
- Require access to liquid funds.
Most banks offering high yield savings accounts restrict this business to their online banking divisions, to keep overhead low. In exchange for managing your savings account online, a bank is more likely to pass along their savings in the form of higher interest rates or waived monthly service fees. However, experts caution depositors to review the fine print of deposit agreements. State and federal laws may require banks to charge you a penalty for making too many transfers or withdrawals from your savings account each month or each year.
Opening a savings account online usually takes just a few minutes and requires linking your account to an existing checking account. Competitive banks allow you to transfer funds electronically, with no fees and no minimum deposits. Some online savings accounts even offer fee-free debit cards, allowing you to access funds at local merchants or at a convenient network of automated tellers. If you intend to use your short-term savings for major purchases, such as covering a tuition bill or making a down payment, high yield savings accounts are often the right tool.
Money Market Accounts: Better Interest Rates for Larger Deposits
As the name suggests, money market accounts (MMAs) leverage the power of financial markets to generate interest for depositors. Instead of using these deposits to fund mortgages and other credit instruments, banks reinvest your savings into traditionally secure, short term holdings. Treasury bills, bonds, and other stable investments tend to make up the bulk of banks' money market account investments. Banks pass along their own dividends to you in the form of higher interest rates, usually one to two percentage points higher than those of traditional savings accounts.
Because money market accounts are regulated and managed differently than typical savings accounts, they often come with restrictions. Most money market accounts require initial deposits of $2,500 or more. Although some banks allow new customers to start accounts with as little as $1000, significant fees for maintaining less than a minimum balance can quickly negate the dividends from your higher interest rate. On the other hand, maintaining a money market account at the bank where you also hold a mortgage can often earn you a discounted mortgage interest rate or a reduction in closing costs.
Depending on your bank and on your state of residence, you may also qualify for check-writing privileges on your money market account. This feature makes it easier for you to use a money market account to save for, then pay for, large purchases or major expenses. However, most money market accounts restrict the number of times each year that depositors can remove funds without being charged a fee.
Money market accounts appeal to depositors who:
- Can afford to start an account with more than $2,500,
- Prefer to have access to live tellers,
- Enjoy the flexibility of writing checks from the same account, and
- Require access to liquid funds.
Many new savers often confuse the money market accounts offered by banks and credit unions with the money market funds offered by brokerages. Although both savings instruments leverage the power of short-term investments to generate interest, only money market accounts from chartered banks carry federal insurance for deposits of up to $250,000. Like other mutual funds in your portfolio, a money market fund may fluctuate in value, or even lose money over time. Therefore, be sure to verify with your bank that your deposits are going be held in a money market account and not used to buy shares in a fund.
Certificates of Deposit: Best CD Rates Require Commitments
Many financial planners counsel their clients to take any money they might need in the next five years out of the stock market. A growing number of Americans have taken that advice even further, opting to keep their cash away from Wall Street until global markets stabilize. Investors with more money to save, but with a need to make routine withdrawals, often prefer to hold certificates of deposit.
Certificates of deposit appeal to savers who:
- Don't need access to their funds within a few months,
- Require FDIC insurance for deposits over $250,000, and
- Can organize paperwork for multiple accounts.
Banks often offer significantly higher rates of return on a certificate of deposit than on a savings account to attract long term investors. When a bank knows that it does not have to cash out a CD for one, three, or five years, it can use that deposit more aggressively to make home loans or to fund credit card accounts for other customers. Likewise, requesting an early withdrawal can trigger stiff penalties. Therefore, many financial advisors recommend using a "laddering" technique to leverage the best CD rates without sacrificing flexibility.
Using a five-year time horizon, you can stagger the terms of your certificates to mature every three, six, or twelve months. This way, some portion of your savings is always accessible to you on a quarterly basis. You can then choose to cash out your certificate, or to roll it over into a new, longer term certificate. This strategy requires a higher degree of organization and record keeping than a high yield savings account. However, with help from a financial planner or an accountant, your investment in time can net you significantly higher dividends over a long period of time.
If you plan to invest more than $250,000 into a certificate of deposit, you can still enjoy FDIC insurance on up to $50 million through an innovative interbank agreement. Under the CDARS program, participating banks automatically open holding accounts in your name at other participating institutions. This process may sound confusing, but it is actually handled electronically and transparently by the account managers at your bank. Although you still maintain your relationship with a single bank, this process ensures that if any bank in the CDARS network fails, your individual accounts remain below the qualifying cap for FDIC coverage.
Finding the Best Savings Bank Interest Rates
In the past, investors discovered the best guaranteed interest rates by watching branch windows or billboards for special announcements. Today, sophisticated savers have more tools at their disposal to learn about special bank offers.
Three of the most effective techniques for finding the best interest rates are:
- Hunting for the best interest rates online. With no drive-thru windows or expensive lobbies to pay for, online-only banks can offer rates of return that most brick-and-mortar branches can only dream of.
- Leveraging your entire portfolio. If you intend to invest a large amount of money through a single institution, speak with a branch manager or a call center supervisor about whether they can match today's best online interest rate. Many banks are so eager for long term deposits, they have empowered team members to do whatever it takes to build loyalty.
- Looking for multi-account bonuses. Some banks now offer special incentives to customers who maintain a variety of accounts at once. Holding a checking account, a money market account, and a few certificates of deposit at the same bank can earn you better interest rates or cash rebates.
Most of all, experts advise investors to be wary of the nickel-and-dime fees charged by some banks. These service charges can eat away at seemingly high interest rates, sometimes leaving savers holding less than their initial deposits. Banks may charge fees for speaking to live tellers, checking balances, or requesting copies of statements. By taking the time to review the market and to compare competing banks, you can protect your short-term and medium-term savings from risk while maximizing your returns.
