Savings accounts are safe places to store cash you may need on short notice. You can open one at nearly any bank or credit union, often entirely online and with only a small or even no initial deposit. These accounts reliably pay the stated rate of interest and most have modest fees while some charge no fees. However, the interest earned on savings accounts is too low to keep up with inflation, raising the question of whether savings accounts are worth having at all. Despite this, most Americans do use savings accounts and they offer important benefits. A financial advisor can help you set up budgeting and savings habits.
Savings Account Basics
A savings account is a type of account offered by a bank or credit union that pays you interest exchange for the use of the money you deposit. These financial institutions use the money in savings accounts to make loans to individuals and businesses.
Nearly all banks and credit unions, including online banks, offer savings accounts. You can open a savings account by filling out an application and making a deposit. Often, you can do this entirely online and sometimes without depositing any money to start.
Savings accounts charge low service fees, typically only a few dollars a month. Some savings accounts charge no monthly fees at all. Savings accounts generally allow withdrawals by online transfer, use of an ATM card or by visiting the bank, However, they are different from checking accounts, which are also offered by banks and credit unions.
Checking accounts, some of which pay interest as well, are designed to be used to pay bills and make frequent withdrawals. Savings accounts, on the other hand, often limit how often you can withdraw money to a few times per month or less.
Savings account interest rates are generally much lower than the returns investors can expect on stocks and similar investments. Currently, many major banks offer annual percentage yields of only 0.01% on savings accounts. High-yield savings accounts offered by some smaller and online banks may pay 2.0% percent or more.
Money deposited in savings accounts is considered absolutely safe from loss. That’s because savings deposits are insured by the Federal Deposit Insurance Corporation. No one has ever lost money from an FDIC-insured account. This safety comes at a cost, however. That’s because the low interest rates paid on savings do not allow savers to keep up with inflation. Money put into a savings account will usually lose purchasing power over time.
Many savers use savings accounts for emergency savings and to accumulate funds for short-term goals or to make major purchases, such as a down payment on a home. Because savings accounts are separate from the checking accounts used to pay bills, many savers find it easier to avoid spending the money on an impulse.
Savings Accounts Pros and Cons
To help you evaluate the benefits and advantages of savings accounts, here’s a table with the key features laid out:
Pros and Cons of Savings Accounts Pros Cons High Safety Low Return High Liquidity Loss of Purchasing Power Separation From Other Funds Less Availability Than Checking
Keep in mind that not all savings accounts are created equally, and each of these may apply in different ways to different accounts.
Best Uses for a Savings Account
A savings accounts is probably the best place to keep emergency savings. These are savings, ideally amounting to one to three months of basic expenses, that are kept in case of any emergency such as a costly repair bill. The separation and high liquidity offered by savings accounts make them well suited for this purpose.
Savings accounts are also good ways to accumulate funds for short-term savings goals that will come due within three years or so. A home down payment, a new car, a wedding or a vacation are common short-term savings goals employing savings accounts. Savings accounts are better for accumulating funds for short-term needs than other investments, such as stocks, because there is no risk of the value of the account declining just when funds are needed.
People who have a very low tolerance for risk are also good candidates for savings accounts. Highly loss-averse investors may keep more money in savings accounts than other investors, simply for peace of mind. However, even savings accounts are not completely risk-free, because of the likelihood that funds will lose future purchasing power due to inflation.
The Bottom Line
Savings accounts are convenient, safe, low-cost places to build up savings for emergencies or major purchases. However, the low interest rates they pay mean inflation will eat into the purchasing power of money kept in them. Balancing these pluses and minuses suggests that keeping some but not all your money in a savings account makes sense for almost everyone.
A financial advisor can help you decide how to use a savings account in your overall strategy. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Savings accounts are considered equivalent to cash for purposes of asset allocation. However, physical currency is not the same as money in a savings account. Bills and coins can be stolen, lost or destroyed, while savings accounts funds are safe from this sort of loss. Hiding money under a mattress or even in a locked safe is not as secure as using a savings account — plus savings accounts at least offer some interest.
Photo credit: ©iStock.com/Prostock-Studio, ©iStock.com/shih-wei, ©iStock.com/damircudic