Guest Post by Christine Lukes
Earmarking funds in the general checking account for future uses may seem like a good idea on paper, but it rarely works out. Checking account funds can too easily be spent on the everyday necessities. They will also decline more or less in value over time due to the fluctuating rate of inflation. It is best to investigate savings options for earmarked funds, and choose the one that maximizes interest-based earnings while matching your need for liquidity.
Savings and Money Market Accounts
Banks offer several savings options, and the general rule is greater liquidity means lower interest rates. The savings account, sometimes referred to as a passbook account, is a good starter for people living month-to-month. Most require no minimum amount to open and offer a low interest rate. Funds can be accessed as easily as with checking accounts, but there are usually penalties for accessing them too often.
Money market accounts are similar, but they require a larger minimum balance, often around $1000. These accounts have higher interest rates, and the maximum withdrawal per month is typically smaller. Penalties exist for overuse and falling below the minimum balance.
There are two advantages to these accounts. They allow saved funds to avoid the value reduction of inflation while remaining somewhat accessible. They are also backed by the FDIC, which means your savings is insured by the federal government. The downside is that low interest rates may or may not exceed the rate of inflation.
Certificate of Deposit
Another government-insured option is the CD. This is a savings account that trades off liquidity for higher interest earnings. The time-frame for the account is set in advance, generally anywhere from 3 months to one year, and the choice of a longer investment will provide a higher, fixed interest rate. Penalties for early withdrawal are usually designed to wipe out interest earnings.
Bank deposits in the form of CD, savings, or money market accounts are not created equally. Your primary bank may not offer the best deal, and it is worthwhile to look at other bank rates in your area and search banks online. Before investing funds in any bank account, check to ensure FDIC participation. Another thing to remember about bank savings is all earnings are subject to both federal and state taxes.
US Savings Bond
Another great way to save, minimize risk, and earn interest is with Treasury Bonds. They are especially beneficial for those worried about the effects of inflation, because the fixed interest rate is combined with the semiannually calculated inflation rate. Another upside is that states are prohibited from taxing any earnings from federal bonds. Federal taxes may be waived when bonds are used to pay for education. Opening a TreasuryDirect account allows bonds to be purchased with a minimum as low as $25.
The benefits of savings bonds come with a price. They cannot be redeemed until after at least one year, and penalties exist for redemption before five years. If you are not worried about liquidity or can afford to set aside a little money every month, savings bonds will continue accruing interest for up to 30 years.
Other methods of savings, such as retirement accounts and education accounts, may provide great returns, but they tend to introduce more risk. The four options for saving discussed above are great ways to avoid risk while still getting a return on the investment.
Christine Lukes is a personal finances guru and a freelance blogger. She often recommends investing into a Certificate of Deposit for a great way to earn some interest on any cash you aren’t planning to spend immediately. Learn more about cd rates savingsaccount.org.