I’m about to talk about Savings, and if your response was “Savings?…SAVINGS?!?!” and you proceeded to fall to the floor laughing at the prospect of having any extra disposable income, then this post is especially for you. A lot of us freak out when someone talks to us about saving. I mean, damn, we are young, at the bottom of our career ladders, rent taking up half of our income, student loans to pay, and not to mention food. And we’ve had bank savings accounts before, and those measly pennies of interest they give us each month ain’t exactly an incentive to forgo that cute dress or a night out on the town.
So before I get into this, I’m gonna dispense with the apprehension about what we are talking about. I won’t talk about “Saving” or even the dreaded “Budgeting,” but instead about “Asset Building” and “Wealth Management.” Because that’s what this is really about: managing your money so you can accumulate wealth. So you can put deposits down on assets: a car; a home. So you can support your children through college and beyond. So you can retire on that beach someday and know you will never have to work again.
But this is The Now, and I can only afford to put aside so much. And even if I “manage my wealth” it would take me forever to build up real assets. Well, I got news. While half of the asset building battle is about how much you can put aside, the real way people accumulate wealth is by taking advantage of the financial system and putting their money to work for them. Let’s look at the “asset building” options, but first a little banking 101.
Ironically enough, banks do not save. They take the money you give them and lend it out, through credit cards, loans, and mortgages, and collect interest to accumulate even more money (I will elaborate more on this system in my next post on Debt). But banks have to insure themselves against the ol’ bank run: the risk that you and I and everybody else might pull out our money at once, money which they don’t have available to spit out those ATMs. Thus, banks will pay you to keep your money in there. That’s how the asset building begins.
Regular Savings
Most basic free savings account pay you only pennies in interest, simply because they have no guarantee against you spending that money. Since you can transfer or withdraw funds easily, the money they had hoped to lend out could be here today, gone tomorrow. This is not an account for building assets. That being said, banks these days are anxious to get more deposits, so even these accounts are paying a little more as of late.
Money Market Savings
Money Market Savings accounts pay you much higher interest rates as the banks begin to insure themselves further. Most such accounts have minimum balances–they’ll slap you with a pretty fee if you go below–and limit the number of times you can withdraw from them each month. Feeling comfortable that you will always have at least, say, $1K in your account, the banks become more willing to pay you higher rates to encourage you to keep even more money in there. The longer you keep money in here, the more you will accumulate.
Certificate of Deposit
I try to withdraw small amounts at a time because it always seems that the more cash I got on me, the quicker it disappears. I become generous as hell, buying drinks for everyone. The Certificate of Deposit (CD) is for those folks like me that can’t trust their own selves to not spend that money. These are fixed term deposits–ranging from 3 months to multiple years–whereby you agree to deny yourself access to your money for the duration of the CD in exchange for higher interest rates. Banks love these, and will even give you higher rates of return if you are able to put aside larger amounts of money.
High Yield Online Savings
High Yield Online Savings Accounts are real hot these days. Online banks do not operate branches, and thus save mad cash on property, staff, security and all that mess. With that extra money, they can offer you rates as high as some CDs while still giving you unrestricted access to your money by linking them to your regular bank account. ING gets all the respect because they were like the OG of online savings, but even traditional banks like HSBC and WaMu are getting in the game, and some lesser known ones like FNBO are paying even higher rates these days. Get one of these and start watching your money grow.
These are the safe options, in the sense that the money you put in a bank is FDIC insured, meaning the government will guarantee your dollars even if the bank does something stupid like pour all your money into default-prone sub-prime mortgages. If you have a thirst for risk though, then you can think about investing, where you can earn even higher returns but could also lose it all…but that’s another discussion. In the meantime, Bankrate.com is a great resource for comparing rates from different banks and has calculators to help you see how much you can earn. Research which one is best for you and start building wealth!
MannyFresh
Stay tuned for my next post on Savings’ evil step-child, Debt, to get the skinny on credit.
{ 8 comments… read them below or add one }
Very helpful.
Where does the IRA and the Roth IRA fit in with the other modes of saving?
Thanks Manny. I found this really thorough and helpful. i’m glad i have a money marketing savings account and more glad that i finally know what that means.
i’m looking forward to the next one because as you know, grad school left my behind seriously in debt. boooo!
Great question Barbara.
IRAs are complex instruments but i will try to simplify them here.
An Individual Retirement Account (IRA) is a private retirement savings plan under US tax code. A person can make contributions to that account throughout their career, direct the custodian of the account (i.e. a bank or mutual fund) to invest your money as you choose (i.e. stocks, bonds, CDs, etc.), and then you can withdraw the funds once you turn 59 1/2 (don’t ask me why it’s that age).
Similar to a 401(k), the principal advantage of an IRA is its realized tax benefits, and the difference between a Traditional IRA and a Roth IRA is how these benefits are realized.
In a Traditional IRA, your contributions are tax-deductible, meaning, for example, you could contribute $3000 one year and thus reduce your tax liability by $3000 for that year. When you retire, though, the money you withdrawal from your IRA will be taxed as income at that time. This will save you money primarily in the short-term. It could also save you money in the long-term if you think you expect to be in a lower tax bracket when you retire than you are when you contribute.
A Roth IRA is kind of the opposite. Your contributions are taxed in the present, when you make them, but at retirement you can withdraw the money tax-free. This is a good option if your IRA earns a lot of money and if you expect to be in a higher tax bracket when you retire.
In both cases, you do not pay taxes on earnings within the account (i.e. additional money made through investments). However, recall that in a Traditional IRA you will pay taxes on the money you withdraw during retirement.
These are great options for retirement savings because you can put your money to work for you while potentially saving on taxes. But this is strictly for retirement savings and you cannot access this money until you are old, grey and ready to sit on the beach all day.
p.s. I should also note that, in IRAs, there is a cap on how much you can contribute each year (currently, I believe it is $5,000). The cap gets raised when you get closer to retirement.
Thanks Manny for the info. I was just wondering because I watch Suze Orman’s show from time to time and she often advises the young to put there funds in a Roth IRA. That’s why I need to stop playing and get her book like ya’ll told us to do, hehe.
Thanks again. This info will come in handy once college is behind me and the working world is upon me.
yeah boo!
Thank you for this article! It was very informative, and I think I got a better grasp on bank-related issues here than I ever have before.
I do have a question, though: With CDs is there a minimum deposit amount?
Yes Sara,
CDs almost always have minimum deposit amounts, but they range widely. There are some with minimum deposits as low as $500 and then there are the “jumbo” CDs that require deposits upwards of $100,000.
They also range widely in terms of length; some can be as short as one month and some go up to 5 years.
Rates and returns will vary depending on these two factors, so use calculators to figure out which is best for you.