“Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t, pays it.” – Albert Einstein
Savings accounts: almost everyone has them, but almost no one is maximizing their benefits. While it’s important to use a wide variety of financial services and diversify your investments, the simplicity, accessibility, and lack of risk involved with a savings account make it much more important and useful than many people realize it is.
However, there are certain things that must be done for a savings account to truly work for you. When a savings account is working for you, it is:
- Providing consistent, high return on investment
- Paying out at the highest possible rate
- Keeping your money accessible in case of emergencies or other investment opportunities.
If your savings account isn’t meeting all of these criteria right now, it might be time to put more money in or ask your banker about other options. To maximize your savings account earnings, try putting these three important tips into action.
1. Consider using multiple savings accounts.
Provided you’re organized enough for it, using multiple savings accounts can increase your earnings and make your financial life more convenient.
Why use multiple accounts? It’s simple. Our culture at large tends to take a one-size-fits-all approach to savings. However, people need different options, and banks in many cases offer them. Taking advantage of diverse approaches to saving can make the savings stick.
For one example, I use three savings accounts:
- One is strictly for long-term use—if I retire or find myself unemployed for more than six months, I’ll be using this money; otherwise, it’s staying in the savings account. I only add a little to this account at a time, but because I’ve only withdrawn from it once and the interest rate is high, I’ve managed to squirrel away a good bit of money there.
- Another savings account is essentially an emergency fund. Although I withdraw from it every now and again, I also add a good amount to it every time I make money, and try to keep a minimum of six months’ worth of income in the account at once time. If I lose my job, face a medical emergency, or come across an amazing investment opportunity, I can access this money at any time.
- My final savings account is for short term savings. Although I always keep a little money in it to avoid banking fees, the balance is generally low until I need to save for a near-future event such as taking a long trip or purchasing a car. As soon as I know I’m going to be traveling or making a big purchase in the future, I start throwing my disposable income at this account—this means that I can stay profitable on my regular income even when the big expense rolls in. I think of this account as the exact opposite of a credit card; I’m essentially paying for something in advance.
In addition to the convenience of using different accounts for different purposes, there’s a psychological benefit as well. Saving instead of spending is hard, especially at first. However, I don’t even think about the 5-10% of each paycheck I put into my long-term savings account anymore, and after only a few years of using this method I have enough to live on for six years.
2. Use the right type of savings account for your needs.
If you still think I’m crazy for keeping three savings accounts open, here’s something else you need to know:
- My short term saver is the basic savings account associated with my checking account at my main bank. This makes the money easily accessible, and it’s much easier to deposit all my extra funds at the end of a pay period.
- My long-term savings account is with a credit union. Although credit union accounts often don’t offer the same features as traditional bank accounts, and I can’t get cash from an ATM when I’m traveling, credit union savings accounts sometimes pay as much as twice the average amount that regular bank accounts do. Although I often can’t access the money immediately, I know that I’m making much more with this account; the difficulty of accessing the money also makes it less tempting to take money out for any reason.
- My emergency fund is the same type of account as my short term savings account, but at a different bank. This is also for psychological reasons: although I can set up an electronic transfer and get money overnight, or drive across town and get cash from an ATM, moving money out of this account isn’t as simple as popping it over to a checking account at the same bank.
This is another benefit of keeping multiple accounts open at once: you can tailor the type of account to what you want the account to do for you.
Even if three accounts seems excessive, using both a long term savings account at a credit union and a short term or emergency fund at a traditional bank can help you make more money and overcome some of the psychological hurdles involved with saving.
3. Consider other no-risk savings options.
Many average consumers think there are two ways to build passive income: risk-free savings accounts and risky investments. However, there are a few other risk-free options offered by banks and credit unions that can go hand-in-hand with a traditional savings account or two.
First off, let’s talk about money market accounts. Money market accounts are technically just a subset of savings accounts, but they work pretty differently from traditional savings accounts. That means they come with their own set of benefits and drawbacks. Here are some of the key things that make money market accounts stand out:
- Money market accounts often have much higher minimum balance requirements than traditional savings accounts, often in the thousands of dollars.
- Most money market accounts allow for a certain amount of free use of the money, such as writing up to three checks a month—some even have debit card options. However, be careful—some money market accounts charge fees for using the money in them too often.
- These accounts usually pay much higher interest than traditional savings accounts, and the interest rate is often more variable.
- Money market accounts are often a bit more complicated and come with higher fees and more rules than traditional savings accounts. It’s important to read the fine print with these accounts.
Like traditional savings accounts, money market accounts are insured by the proper federal agencies and perfectly safe to invest in. Because they’re a little more complex and require a higher minimum balance, I recommend money market accounts to individuals who are already a little bit experienced at saving.
Also, it’s important to do some shopping around before opening a money market account. While fees and interest do vary for regular savings accounts, most major banks are on the same page. However, when it comes to money market accounts, there are huge disparities in both interest paid and fees required by different banks.
Another important type of no-risk savings option is the Certificate of Deposit, almost always abbreviated to CD. Instead of a savings account, think of this as a loan to the bank—but don’t worry, CDs are also insured by the FDIC, so there’s no way to lose money investing in a CD. Here’s how it works:
- You put a certain amount of money in the CD when you open it. Minimums for CDs are often higher than traditional savings accounts, but not as high as money market accounts; many are in the $100-$500 range, though some require as much as $2,500.
- This money is “locked in” for a period of time agreed upon when you open the CD. Generally this can be as short as six months and as long as five years, but different banks have different options.
- You can still withdraw this money in the event of an emergency, but you’ll face a significant penalty that will eat up most of the interest you’ve earned, and could possibly even damage your initial deposit. This is the only “risk” associated with CDs, so make sure you’re investing money you won’t need right away.
- When the CD “matures” (reaches the agreed-upon end date), you can either reinvest in a similar CD, cash out, or look at other CDs or similar products. However, it’s important to let your bank know in advance—if you don’t say anything, their default option is to put your money in another CD.
CDs certainly come with more restrictions than traditional savings accounts and money market accounts, but they also pay much higher interest rates. Aside from the fact that your money will be locked up for a period of time, there’s no risk involved. Also, they’re very low-maintenance.
CDs are a great option if you are an experienced saver or you have come into some extra money (such as a holiday bonus). However, you don’t want to park too much of your money in CDs at one time, as this can result in you taking a financial hit later.