Choosing the Right Type of Savings Account for You
After months of dealing with remodeling filthy and impossible to clean wood floors, I want rugs. Not just any type of rug, the kind your feet sink into. The kind made to last between moves and that won’t be ripped apart by an overeager vacuum. But, the price for such a rug isn’t cheap.
Next summer I want to take a trip up the east coast, venturing between bed and breakfasts and finding lighthouses to explore. Airfare for two and accommodations far more “adult” than I’ve required in the past will require an extended amount of financial planning.
Three to five years from now, when my business is more than a desk in a guest bedroom, I’ll want to start a family. In addition to baby names and nursery decorating, I’ll have to address the financial implications of not having maternity leave.
Each of these goals will require the same thing: clarity, planning, and budget maneuvering. But there is one substantial difference I'll need to consider when planning for each of them:
Where will I be saving the money?
Types of Savings Accounts
Last tax season I opened a SEP IRA. I wanted to offset my tax obligation and continuing saving for retirement in a way that worked with my self-employed status. As I set up the transfer of funds, I felt as if I was preparing to pay a major bill. In my mind, money sitting in a savings account was mine, but money invested in a retirement account was someone else’s.
This is my entire relationship with saving in a nutshell: If I can see it as one lump sum and access it, it’s real. If it’s divided between several accounts, not all of which are accessible, it seems less real and not as substantial. Strange, I know.
But understanding this about myself is important. I know I tend to lean towards hoarding money in a savings account - it’s comfortable, not logical. Better financial options are at the edge of my comfort zone. Things like utilizing different accounts for savings goals and incorporating investing when appropriate, while smart to do, aren't the easiest things for me to do. With that said, these things are important for me and for everyone looking to grow their income.
But the question is, which are the best savings accounts to help you do so? It really boils down to two things: the amount you're trying to save and the timeline of your goal. But first, let's talk about all the different types of savings accounts there are to choose from:
Standard Savings Account
Best for: Short term goals (0-1 year away) and emergency funds
Pros: Savings accounts are simple to set up and easy to access should an emergency arise. Funds can be transferred quickly if connected to a checking account.
Cons: Interest rates on savings accounts are below 1% at most banks - lower than the rate of inflation. This means your savings could lose value over time. (Find banks offering the highest interest rate here.)
Money Market Accounts
Best for: Short term goals (0-1 year away) and emergency funds (as long as you don’t dip into your emergency fund too often)
Pros: Money market accounts offer the same protections as a savings account, but with the potential to earn more in interest. (See interest rates for the top banks here.)
Cons: While there is some ability to write checks and transfer funds from a money market account, this activity is generally more restricted than with traditional savings accounts. Minimum balances also tend to be higher.
Best for: Mid-term goals (2-3 years away)
Pros: CDs offer a guaranteed return that can be higher than a savings account. But you have to be able to let that money sit. As long as you know you won’t need to access the funds before the maturity date, then this could work. If you need less risk than investing, it’s a good option to look into.
Cons: In a low interest rate environment, the amount you’ll earn is small - especially when you consider the amount of time your money will be tied up. (Find current CD rates here.)
Best for: Mid to long term goals (2+ years away)
Pros: Investing allows the potential to see larger returns in a shorter amount of time than with savings accounts or CDs. You can also adjust your risk level by changing your allocation between stocks and bonds. (Find top brokerage accounts here.)
Cons: Should a market downturn occur, you could lose some of your initial investment and not have the time to recover before you need the money.
Retirement Accounts (Think: 401k, 403b, IRA, SEP IRA)
Best for: Long-term goals (10+ years away, depending on your age)
Pros: Designated retirement accounts provide a tax break now (by lowering your taxable income) or at retirement (by allowing you to remove funds tax-free when your tax rate could be higher). This will depend on the type of account you have (Traditional 401k vs. Roth 401k, for instance). Good retirement accounts will allow you to build a substantial nest egg with low fees. (Find retirement accounts here.)
Cons: Not all retirement accounts are created equal. Some have a fee structure that can eat away at what you earn. In addition, there are penalties for removing funds before a specific age (which might not be a bad thing...).
How to Determine the Savings Accounts Right for Your Goals
While it’s not logical to see the money in a savings account differently than the money in a retirement account, there is one way this thinking helps me:
I handle risk better this way.
I am, and have always been, risk averse. But because I tend to think of my retirement savings in a completely different way, I keep my portfolio at a risk level acceptable for my age. If I didn’t, bonds would be my go-to and I would never be prepared to leave the working world behind.
Admittedly, the rest of my savings goals - even if they are on a 5-10 year timeline - don’t see the benefits of investment growth. This is something I’m working to change.
Now that you have an overview of the different types of savings accounts, here's what to think about in choosing the right one for you:
Saving is equal parts mental and transactional. Therefore, your mental capacity for risk needs to be addressed in addition to the level of risk your savings goals can handle.
If you tend to be overly risky (throwing money into volatile stocks at the drop of a hat) this will need to be tampered down with the reality of how this could end up stripping you of your investment. Or, if you tend to avoid risk like me, you’ll need to come to terms with the fact this could keep your money stagnant.
Reaching a compromise between these two things will help you pin down where you'll feel comfortable keeping your money.
This brings us to another key element: the timing of your goal.
My goal of finally completing my living room renovation with durable rugs is a standard savings account goal. But my goal of taking maternity leave in 3-5 years would be better off in conservative investments. (It might even be better of in a CD, depending on how high the rate is. And depending on whether or not I come to terms with my aversion to risk.)
Timing is also easier to determine if you have a clear delineation between your emergency fund and your savings goals. Some types of accounts don’t offer easy access. Therefore, if you want to make the best account decision for your savings, your emergency fund will need to live elsewhere.
Depending on what you’re saving for, growth might be a moot point. For instance, if you were hoping to buy a $300 plane ticket in three months, growth in any type of account probably wouldn’t move up your goal achievement date. Returns in a retirement account, however? That could cut years off your working life - or add them, depending on the severity of the situation.
Understanding how growth could play a part in each of your goals will help you understand the type of account to look for.
How to Pick the Right Service Provider
All banks are not created equal - not by a long shot. All it takes is a quick look at the various interest rates being offered by different banks to prove that point.
That's why it's important to not just pick the right savings account for you, but also to pick the right bank to hold that savings. Some things to consider:
Step number one in determining where to open an account: finding out if they even offer what you’re looking for.
Simple enough, right? Let’s move on.
Even if you have a short-term savings goal and therefore just want a traditional savings account, why not cash in on the best rate you can get? In many cases this will be with an online bank. After all, without physical branches to pay for, online banks can save on overhead and bring that benefit to you. But even if you’d rather not go with an online bank, there are differences in the interest rates offered by traditional banks as well.
Do your research and make sure you’re giving your money the ability to grow - even if it’s not required, or the amount is small.
If investing your money is how you plan to reach your savings goals, robo-advisors like Betterment will help you select an allocation based on your goal timeline. But maybe this type of digital, set it and forget it saving isn’t something that feels right to you. In that case, talk to a financial advisor to get set up with the right investment account for your goals.
Knowing what works for your lifestyle will help you select the best bank for you. For instance, would you rather have access to a good mobile phone app or access to a branch near your home? Review what the bank you're thinking about has to offer to make sure it will work for you (and not the other way around).
You’re Saving - That’s What Matters
While my savings game isn’t perfect and I continue to worry about reaching bigger benchmarks, I’ve created a habit of putting money away. That’s what matters. This makes saving for everything from travel to having a family not just possible, but probable.
Even if you haven’t figured out the mechanics of saving just yet, pat yourself on the back for starting the process. You’re actively pursuing the life you want and that deserves some recognition.