As a result of the financial crisis caused by a global pandemic, people are saving more than ever before. According to the U.S. Bureau of Economic Analysis, in the span of one month between March and April 2020, Americans went from saving 12.7% to 33% of their income! That raises an important question: Where should you save that money?
The natural tendency is to stash your cash, like under a mattress or in the sofa, right? In that case, you better remember where you stashed it. When I was younger, I hid a $20 dollar bill in my desk and completely forgot where I hid it, only to discover it a decade later. If you can remember where you put your money, you might be tempted to spend it. Doesn’t that already happen with money in your wallet?
The better choice is to use a savings account. Here’s why. Your money is out of sight, out of mind. Unlike storing money within reach in your house, putting money elsewhere discourages spending it. The good news is that if you need cash, savings accounts offer liquidity, meaning they provide access to your money without costing a fortune in fees or taking forever.
The most important reason to store your money in a savings account: Interest. This is the key difference between keeping your money in a piggy bank or in a checking account, neither of which earns any interest. Banks typically offer interest on savings accounts as an annual percentage yield, or APY. For instance, 2% APY means you earn $2 dollars when you place $100 in that savings account all year long. If you don’t touch that savings for another year, you will earn a little more next year because the APY is calculated on $102 vs. $100 originally placed in the account.
Behind the scenes, the reason banks can pay interest is that they earn interest themselves through lending money. By placing your money in a savings account, you are providing additional funds that the bank can use for lending, with a promise to return your money when you need it back. Trusting someone else with your money is not easy, but choosing an FDIC-insured bank will protect your savings account from any loss up to a certain limit (currently $250,000), if the bank should ever fail.
Choosing the right savings account will depend on your own preferences and comfort. Interest rate may play a factor as well, since some accounts trade certain conveniences or features for a higher interest rate. Do your research beforehand. Inquire with banks you have relationships with, and check out some expert recommendations, like this one from MONEY Magazine.
You may be tempted to put all available cash into a savings account. Keep in mind that withdrawing money is easier from a checking account, which offers checks, a debit card, and the ATM. Plus, the point is to have limited access, keeping a savings account sacred for emergencies or earmarked for specific goals. Therefore, consider opening a savings account after you have set aside 1 to 3 months of cash in your checking account. That way, you can still use cash on a daily basis from your checking account, but have back-up funds waiting in savings.
We all know that saving money is important, but where you save makes a difference. Why let your money sit idle when it could be making money? That’s the power of a savings account!
Homework: What’s the APY on your savings account? If you were to add $500 a year, how much more interest would you earn? What about $1,000 a year?
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