Having an emergency fund is the best way to prepare and protect yourself from unexpected financial difficulties.
And that means having a savings account. Savings accounts are a great way to store your money and earn extra money in the form of interest. They can help you meet your financial goals, ensure you have cash for emergencies, and generate modest returns.
With so many options available, finding the right savings account can be confusing, but don’t let that stop you from building smart savings habits so you can be prepared for whatever comes your way.
What is a savings account?
A savings account is opened at a bank or credit union and is used to store money that is not used for day-to-day transactional purposes, such as a checking account.
Banks generally pay a higher interest rate on savings accounts than on checking accounts, which generally pay no interest, meaning you can earn extra money to keep your funds there.
“If you have extra money and aren’t comfortable investing it, a savings account can be a great way to get a bit of a return or return,” says Sri Reddy , senior vice president of retirement and income solutions at Principal. Financial Group in Des Moines, Iowa.
Plus, savings accounts are FDIC-insured, which guarantees your balance up to $250,000 per bank in the unlikely event that it goes bankrupt.
Why do you need a savings account
Savings accounts offer the right balance of liquidity – less accessible than your checking account but much more available than certificates of deposit (CDs), savings bonds or other investment accounts.
What really sets a savings account apart, especially for holding emergency funds, is that you can access the money immediately if needed.
“You want your emergency fund to be liquid,” says Rebecka Zavaleta, developer of personal finance brand, First Milli. “You want it in a place where you can easily take it out.”
Choose your account
When deciding which type of savings account to open, Reddy recommends determining the features and degree of accessibility you need to feel comfortable with. Your decision will likely come down to choosing between a traditional savings account at an older brick-and-mortar bank and a high-yield savings account at an online bank.
Some questions to consider:
- Will the account provide a debit card from which you can access savings? Most savings accounts do not offer debit cards, but some may offer the option of ATM cards.
- How soon do you need to access the withdrawn funds? Can you wait a few days if needed? Online-only savings accounts will require a transfer to a local account if you wish to withdraw directly in cash.
- Do you want the savings account to be at the same institution as your current account?
- Do you agree to have different banks to get the best return? Online-only savings accounts can often offer a higher interest rate for your money.
If you want to put your money in a traditional savings account, think seriously about the benefits you get from the branch and ask yourself if it’s worth forgoing the significantly higher returns with an online bank.
Online or physical savings accounts
Online-only banking has grown in popularity in recent years, and you can usually find better savings account rates at online banks.
An August 2020 NextAdvisor survey found that only 21% of banked adults currently have a high yielding savings account, and others are missing out on potential returns by only using a low yielding alternative.
High-yield savings accounts are more commonly found in online banks, so again, asking how accessible you want your funds to be could be a deal breaker.
Find out the best interest rates for high-yield savings accounts with NextAdvisor’s rate tracker.
Online-only banks do not have a physical location you can withdraw your funds from, so it may take a few days to transfer money from an online-only account to an account associated with a physical bank if you need to take cash.
Although a brick-and-mortar location provides some convenience, banks that maintain nationwide networks of physical locations incur additional costs of doing business, so you may not get the best rate.
Aside from access and returns, “there aren’t many differences with the underlying account holder,” Reddy says. “Whether it’s a [traditional] savings account or a high yield account, they all work the same way. I encourage people to seek out the savings account that gives them the best access and return they can get. “
How to open your account
Opening a savings account works the same way as opening a checking or other bank account. If you’ve never opened a bank account before, don’t worry. You can usually apply entirely online, and you’ll only need a few personal details to hand, such as your government-issued ID, social security number, and money for an initial deposit on your savings account.
How much should you save?
When planning how much you should start saving, “don’t leave free money on the table,” says Reddy.
Start by determining if your employer matches contributions to a retirement fund and start saving there first. If you can, contribute at least what will be matched by your employer. How much you should contribute beyond that depends on a few factors.
After determining what retirement options you have access to, Reddy recommends building an emergency fund of three to six months of expenses so you’re prepared if you face unforeseen circumstances.
There are many varied tips on how much money you should keep in an emergency fund, but start small and remember that anything is better than nothing. Make growing your emergency fund a goal to work towards over time.
“After having a nice three to six month emergency fund, I would advise you to max out your Roth,” says Zavaleta, referring to the Roth IRA, a Roth retirement investment vehicle.
Savings accounts are an easy way to store your money safely and earn extra money in interest. The Federal Reserve has cut the borrowing rate, which impacts how much interest you can earn on a savings account, but “just because rates are low doesn’t mean people who save are automatically in a negative position,” Reddy says.
Even if rates are low, opening a savings account is still a good way to develop healthy spending habits and take control of your finances today.