If you’re like most people, you have a savings account, possibly in addition to a checking account and other financial accounts you use on a regular basis. And, like most people, you rely on this savings account as a safe way to store your extra money, whether you’re relying on it as a cushion for emergencies, are saving up for a specific large purchase, or are just trying to get ahead for retirement.
The question is, is a savings account really the best way to store your money?
How Savings Accounts Work
Savings accounts are one of the most basic types of bank accounts you can have. Generally, your bank will allow you to store your money with them, provided you maintain a specific minimum balance (usually something low, like $25). You’ll get access to certain perks, like being able to deposit and withdraw money, managing your accounts online, and a fixed interest rate, which will help your savings grow. Most savings accounts offer a very low annual interest rate, like 0.1 percent, but there are some savings accounts that offer higher interest rates.
Banks typically insure your savings with the FDIC. Though this process can get complicated, the bottom line is that your money will be protected even if the bank goes out of business. How do banks profit from this? They typically take the money you (and others) deposit and loan it to other people, for a higher interest rate than they’re paying out.
The Downsides of Savings Accounts
While savings accounts are secure and easy to create and manage, there are a few major downsides to using them for long-term storage:
- Limited utility. Savings accounts are meant for savings, and not much else. You may be able to conduct wire transfers, but you won’t be able to make purchases as conveniently as you could with a checking account. You also aren’t able to use your savings account to directly purchase investment assets, like stocks and bonds.
- Low interest rates. The interest rate for most savings accounts is terribly low, often lower than inflation. Typical savings account interest rates hover at less than 1 percent, though some high-yield accounts can offer 2 percent or more. For comparison, the inflation rate is something between 2 and 3 percent, meaning in the lowest bracket of interest rates for savings accounts, you’ll actually be losing value over time.
- Fees. Many banks do offer savings accounts for free, but you may have to pay a monthly or periodic fee for continuing to use your savings account.
Saving money is almost always a good thing, but if traditional savings accounts offer more weaknesses than strengths, what alternatives should you be considering?
- High-yield savings accounts. Some savings accounts naturally have a higher interest rate than others. Sometimes this is available only if you maintain a higher minimum balance, but sometimes is offered just because banks want to attract more customers. Whatever the motivation, you’ll do much better with a savings account that has a 2 or 3 percent interest rate than one with less than 1 percent. You’ll also get the other built-in advantages of a savings account, including practically unlimited liquidity and loss protection.
- Money market accounts. You could also consider opening a money market account. These accounts typically have a higher interest rate than a savings or checking account, but they also come with some restrictions. They’re focused on making money with short-term, liquid investments, and are backed with FDIC insurance (typically). They allow you to make withdrawals, but may have restrictions on when and how much you can take out. They also tend to have higher minimum balances than savings accounts.
- CDs. Certificate of deposit accounts (CDs) sometimes offer even higher interest rates than money market accounts, often up to 3 to 5 percent, depending on the terms you choose. In a CD, your money will be held for a specific period of time, oftentimes a year or longer, and during that period you can’t touch those funds without penalty. In exchange for lower liquidity, you’ll get a higher interest rate and security on par with a savings account.
- Brokerage accounts. You could also put your money in a brokerage account or a retirement account, where you can use your money to trade assets like stocks and bonds. These assets tend to carry higher risk than a conventional savings account but may offer a much higher yield.
Savings accounts aren’t usually the best places to keep your money, but you can make them work for you if you choose a high-yield account, and are keeping your money there for a good reason. In a savings account, you’ll have access to more security, liquidity, and stability than other accounts, but the tradeoff is a lower interest rate.