We all know saving money is important, but knowing where to put certain savings goals is a savvy way to earn a little extra, while you continue to save. Instead of dumping all my extra cash into a regular savings account, I prefer to split the money up so I’m always earning the best returns possible. If you’re working towards saving for a dream vacation, a new car, down payment for a house or your retirement, here’s where you should park your savings dollars.
1. Dream vacation: Use an Online Savings Account
Even if you’re an expert at penny-pinching, vacations don’t come cheap. According to American Express, the average spending for summer travel comes to $1,145 per person. If you’ve got your sights set on a dream getaway, you don’t want to wait until the last second to start saving for it.
While you could just stick the money in your regular savings account at your brick-and-mortar bank, going with an online bank instead is the better choice. There are two reasons I prefer an online account for vacation savings — one, online banks don’t charge as many fees as traditional banks and two, you’ll score a better interest on your deposits.
According to MyBankTracker’s latest savings rates, the going APY at big banks like Bank of America® and Wells Fargo is a dismal 0.01 percent. Capital One 360, on the other hand, is offering 0.75% for new savings accounts. That doesn’t seem like a huge difference but if you stick $5,000 in the Capital One account, you’d earn nearly $40 more in interest each year.
2. Car purchase: Use a money market account
Buying a car can cripple your finances if you’re taking on a huge monthly payment but saving up the cash to make the purchase outright can save you some headaches. If you’ve got a couple of years to work on setting aside the money, you can make it every dollar you save work for you by putting it in a money market account.
Money market accounts are offered by both traditional and online banks and they’re basically a savings account with a twist. Instead of having to transfer money from your savings to your checking account, money markets offer check-writing privileges and/or a debit card. The interest rates tend to be higher — see MyBankTracker’s Money Market rates table.
Tip: Because they offer better rates, money market accounts typically require a higher minimum balance to avoid a fee so be sure to read over the account terms carefully before you open one.
3. Down payment on a house: Use a CD ladder
A 20 percent down payment is the industry standard when you’re buying a home and if you’re saving $20,000 or $30,000 towards yours, you don’t want to just put it anywhere. Of course, you want the money to be secure but if you’ve got time on your side, there’s no reason to settle for a measly interest rate.
I’ve talked about where to save your down payment before and out of the different options that are available, a CD ladder makes the most sense if the dream of home ownership is still in the distant future. The way it works is pretty simple: you set up multiple CDs with varying maturity terms. When one expires, you just roll it over into a new CD until you’re ready to pull the money back out and use it.
So why is a CD ladder better than plunking all your cash down into a single CD? For one thing, you can take advantage of higher interest rates by splitting your savings up. As a general rule, the bigger the initial deposit, the better the rate will be.
The other benefit is that you’re in a better position to minimize penalties. Normally, when you cash out a CD early, the penalty will equal six months’ worth of interest. If something comes up and you have to withdraw from one of the CDs ahead of schedule, you don’t stand to lose as much of your earnings.
4. Retirement: Use a Roth IRA
If retirement is still 30 or 40 years off, saving for it may not even be on your radar yet but you can’t afford to leave it off your list of savings goals. When it comes to building a decent nest egg, time is the most powerful factor that can work for or against you. Even if you’re only putting in a few dollars at a time, a Roth IRA can ensure that your golden years are financially secure but you have to get started sooner rather than later.
Consider this example. Karen is 25 years old and making $35,000 a year at her first job out of college. She has student loans that she’s trying to pay off so she doesn’t start chipping in to a Roth until she’s 35. She saves $5,000 a year until she hits age 65, at which point she’s accumulated just over $500,000 thanks to a 7 percent annual return.
That’s not too bad but if she’d started saving that same $5,000 10 years earlier, she’d have nearly $1.2 million in the bank by the time she retires. Not only that, but because her contributions to the Roth were made with after-tax dollars, she won’t owe any additional taxes on the money when she starts making withdrawals. That’s 500,000 reasons not to wait another day to start saving in a Roth.