Too many people misuse their savings accounts. Or worse, don’t have any savings accounts at all.
Savings accounts represent one of many financial tools you should be using to build wealth and meet your long-term goals. Follow these strategies to get the most out of your savings accounts, to minimize risk and maximize gains.
Purposes of Savings Accounts
Assuming you don’t rank among the underbanked, you already have a checking account. Why do you need a savings account at all?
Savings accounts work best when used for a few specific purposes.
Your Emergency Fund
Everyone needs an emergency fund. In fact, setting aside $1,000 to start your emergency fund is Dave Ramsey’s #1 Baby Step — followed not long after by saving three-to-six months’ expenses into it as Step #3.
You need an emergency fund because emergencies are, by their nature, unpredictable. Any of us could get hit by a bus tomorrow and become unable to work. Or lose our jobs, or face a major home repair, or encounter some other crisis that requires cold, hard cash.
While I believe in a tiered emergency fund not just made up of cash but also low-volatility investments and unused credit cards, you certainly need a cash foundation for your emergency fund. And savings accounts make the perfect vehicle to hold that cash.
Use a separate savings account to hold money for irregular expenses.
These expenses don’t hit you every month, and sometimes not even every year. But they’re inevitable nonetheless. Examples include gifts (holiday gifts, birthday gifts, wedding gifts, anniversary gifts, baby shower gifts, ad infinitum), annual or semiannual insurance premiums, home repairs, and car repairs.
Stop me if this sounds familiar: “Well, this month my budget got blown because I had to buy a wedding gift, but next month I’ll get back on track!” Or how about “I had to tap into my emergency fund to spend $3,000 replacing my furnace this year, but next year I’ll get back on track!”
If this sounds like you, you likely won’t “get back on track” next month, or next year, or ever. Because next month it’ll be your sister’s birthday present, or a $500 repair on your car. Next year it’ll be a $5,000 roof bill.
Set aside money for these irregular-but-inevitable expenses every single month. Budget for them, because they’re coming, and it’s irresponsible to pretend they’re one-off outliers rather than the rule.
Short-Term Holding Funds
Preparing to make a major purchase like a new car or home within the next few months?
If you need a temporary holding area for funds that you plan to use imminently, savings accounts make a great place to do so. They’re out of sight from your day-to-day living expenses that you use your checking account for, but they’re FDIC-insured and utterly safe.
Likewise, savings accounts make a great place to set aside money for upcoming travel.
Pro tip: If you don’t currently have a savings account open, start with CIT Bank. There Savings Builder accounts offer some of the highest interest rates.
How to Get the Most Out of Your Savings Accounts
Now that you know what to use your savings accounts for, try these tips to maximize their potential.
Don’t Use Your Savings Accounts for Long-Term Goals
Savings accounts offer two huge benefits: liquidity and security. You can access them instantly if needed, and they come with no risk — your first $250,000 is insured by the Federal Deposit Insurance Corporation.
But even high-yield savings accounts usually pay less in interest than the inflation rate. Which means that your money’s real value erodes over time in savings accounts.
For any purchases or goals that you don’t plan to reach in the next year, invest the money instead. The most obvious example is your retirement savings: invest the money through tax-advantaged accounts and regular brokerage accounts like E*Trade rather than leaving it to sit idle in a savings account.
The same goes for saving up a down payment, if you don’t expect to buy within the next year. As you get closer to buying, you can move the money to short-term investments, or to a savings account.
Take advantage of the power of compounding to reach your long-term goals faster. Move the money to savings accounts only as you near needing to access it.
Higher Savings Rate, Faster Progress
The greater your savings rate — the percentage of each paycheck you put toward savings — the faster you’ll build wealth and reach those long-term goals.
For example, with a high enough savings rate, you can potentially retire within 5 to 10 years. I plan to reach financial independence within five years of when I got serious about it.
Of course, retirement isn’t the only personal finance goal you want to hasten. Want to buy your dream house faster? Build passive income streams faster?
Start by recreating your budget, and rethinking every existing budgeting category. Your budget isn’t written in stone: it’s a starting point on your journey to a better budget — one that will help you achieve your savings goals faster.
Automate Your Savings
Don’t rely on discipline for your good financial habits. Automate everything you can to keep your money flowing into savings and investments.
You can automate savings in many ways. Ask your employer to split your paycheck direct deposit into two accounts: your checking and savings accounts. If they can’t, set up automated recurring transfers from your checking to your savings account — on every single payday. Or you can try automated savings apps like Acorns or Chime.
If you have high-interest debt, such as credit card debt, you can also set up automated payments toward your balance every two weeks (or however frequently you get paid).
Using robo-advisors, you can automate your investments as well. Set up weekly, biweekly, or monthly transfers, and the robo-advisor does the rest, investing in diversified exchange-traded funds (ETFs) or mutual funds on your behalf.
You can even automate real estate investments in using real estate crowdfunding platforms. Try Fundrise, Streitwise, or GroundFloor as options available to non-accredited investors, that all allow you to set up automated investments.
By automating your savings and investments, you also prevent emotional investing, which inevitably ruins your returns.
Strong money habits are all well and good, but automation is far more reliable.
Compare Your Savings Yield to What’s Available
If your current bank doesn’t pay you any interest on your savings, look elsewhere.
Look into high-yield savings accounts to scope out the highest interest rates available today. Banks express this as annual percentage yield (APY). If possible, find a savings account that pays higher APY than the Federal Reserve’s 2% inflation target. Keep an eye on minimum balance requirements on these accounts though.
And don’t be afraid to move your savings account to a different bank than your checking account, either.
Consider Making Your Savings Less Accessible
In today’s world of digital banking, you see your savings account balance every time you log in to manage your checking account, at least if you hold both at the same bank. With a click, you can move money from savings to your checking account and spend it.
For many people, the temptation is too great. Money burns a hole in their pocket. If they see it, they want to spend it.
So? Keep your savings out of sight and out of mind. Set up a savings account at a different bank or credit union from where you keep your checking account. While you may need to log in and view your checking account frequently, the same isn’t true of your savings.
By putting extra friction between you and your savings, not only do you avoid the temptation of seeing it every time you log in, but you also make it that much more difficult to transfer or withdraw. Many online banks offer higher interest rates than brick-and-mortar banks, and you shouldn’t be afraid to take advantage of them simply because you can’t walk up to a teller and demand money instantaneously. Consider that extra friction an advantage of online savings accounts rather than a downside of online banking.
Just make sure you don’t forget about these bank accounts entirely. Use a service like Personal Capital or Mint that tracks all of your financial accounts in one place so you don’t forget where you keep your savings.
Regulation D & Transaction Limits
In April 2020, the Federal Reserve eased rules on savings account transactions.
Historically, the Federal Reserve limited these transactions to six per month per savings account. They did this to help banks maintain their capital reserves and meet their regulatory requirements.
But in the face of the coronavirus pandemic, the Federal Reserve suspended that limit to make it easier for hard-hit Americans to access their savings if needed. The suspension represents an interim rule however, and the Federal Reserve may reinstate the original rule at any time.
Note that even without the rule, many financial institutions still limit how many monthly transactions customers can make with their savings accounts.
Regardless, savings accounts aren’t designed as transaction accounts. They don’t come with debit cards or checks. For your everyday operating expenses, use a checking account.
Savings accounts make the perfect vehicle for emergency funds, irregular expense funds, and short-term holding funds. They aren’t designed to hold money earmarked for long-term financial goals.
If you don’t currently have a savings account for your emergency fund and another for irregular expenses, find a bank offering high-yield savings accounts and open them now.
Maximize your savings rate, set aside money for irregular expenses in your monthly budget, and never raid your savings accounts for discretionary expenses.