Now that we have a better understanding of checking accounts, let’s explore the savings account.
A savings account is useful because it stores money you want to put away for the future. Sure, you could save money in your checking account, but with a savings account you earn a higher interest rate.
If you currently do not have a savings account, I urge you to open an account and deposit money on a regular basis. This is arguably more important than the interest you might be missing out on. Without any savings, you could be caught off guard by any surprise expenses such as large medical bills or unemployment. It’s best to have some sort of emergency fund and be forward-looking with your money. You need to care for both yourself and your future self.
- Earns interest
- Limited number of free withdrawals a month
The number of free withdrawals you can make from your savings account ranges from 3 to 6 a month. There are Federal limits on savings accounts that limit withdrawals to 6 a month.
Bank of America’s standard checking account earns 0% interest. You make no interest on the money you hold in that account.
I currently have a savings account with Ally that earns 0.84% APY (Annual Percentage Yield) compounded daily.
If I have $5,000 saved up and I keep it in my checking account for an entire year, it stays at $5,000.
If I decide to keep that same $5,000 in my savings account for a year, let’s see how much interest I earn:
$5,000 * ((1 + (interest rate)/365) ^ 365) =
$5,000 * (1 + 0.0084/365) ^365 =
In the one year, I received $42 for simply leaving my $5,000 in the savings account.
When you’re comparing savings accounts, the main that matters is the interest rate. I used the example of Ally (the savings account I currently use) to clearly illustrate the free money you could be making. Bank of America’s standard checking account pays a meager 0.05%, which is why I switched.
Besides interest rate, you want to make sure it costs little/nothing to maintain. If you’re making $50 a year in interest and paying $48 a year just to keep it open, then you’re really only getting $2 a year in free money.
Money market accounts (or MMA’s) are essentially the same as savings accounts. As another personal finance blog (The Simple Dollar) notes, there used to be slight differences and MMA’s used to offer a higher interest rate than typical savings accounts, but thanks to the proliferation of internet banks and high-yield savings accounts, the two types of accounts are almost identical in usage.
In the next post, I’ll show you how I picked my primary savings account and why I chose Ally.