Starting with Savings Accounts

Savings accounts are a form of investment — a very safe
form. Although many banks don’t pay interest on checking
accounts, all banks pay interest on savings accounts.
For the most part, interest rates offered for savings accounts
differ only slightly from institution to institution. Prior to
the start of banking deregulation in 1986, banks used to pay
5% daily interest on all savings accounts because federal regulation
specified that amount. Unfortunately, 5% interest
rates on savings accounts are history. Today, the average savings
account earns about 2% daily interest.

Understanding Savings, Money Market Accounts, and CDs 15
Look at the bar chart in Figure 2-1 to see how your money
fares in a savings account investment with a 2% interest rate
and a 3% rate of inflation. Assume that you’ve made an initial
investment of $100 and faithfully add $50 per month for
the next five years.

Although the amount in your savings account reaches
$3,262.88 — $162.88 more than the amount you actually
contributed — the actual buying power of that investment
is only $2,814.59, due to the rate of inflation. That’s
$2,814.59 more than you would have had, had you not committed
to socking away some money for the future. But as
investments go, you wouldn’t want to rely wholeheartedly on
a savings account because the return on your investment is
so low. Of course, factors such as the interest rate and rate of
inflation play a major role in how well your money does in
this type of investment vehicle

Web sites such as www.bankrate.com and financial magazines
such as Money publish lists of the highest-paying savings
accounts each month.

Some banks offer the incentive of earning additional interest
on a savings account by using a tiered account system. This
system enables you to earn higher interest if your account
balance is consistently over an amount specified by the bank.
This amount is usually at least $1,000, but it may be higher.
Most banks charge a monthly or quarterly maintenance fee
for a savings account. Some tack on an additional fee if your
balance falls below a required minimum. In addition, you
might be required to keep a savings account active for a specified
time or face penalties.

What makes savings accounts such a safe investment? If the
bank has Federal Deposit Insurance Corporation (FDIC)
insurance, your savings account is backed by the full strength
and credit of the federal government. If the institution fails,
Uncle Sam sees that you get your savings back — up to
$100,000. As with any other insurance, you may sleep better
knowing that it’s there in the worst-case scenario.
Although putting your money in a savings account has serious
limitations if it’s your one and only investment strategy,
having some of your money in a cash reserve makes sense.