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PASSBOOK AND STATEMENT SAVINGS ACCOUNTS

Published by sam - 28/08/07 - 08:08:53 am

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The traditional savings account—whether its activity is recorded in a passbook or a monthly statement—is safe and liquid. As a result, it pays the lowest rate of interest offered by banks. Prior to the changes brought about by the Depository Institutions Deregulation Act of 1982, the interest payable on such accounts was limited to 5.25 percent for commercial banks and 5.5 percent savings banks. Although banks are now free to offer whatever rates they choose, these rates have not much. Instead, banks offer their customers higher rates for larger or less liquid forms of deposit, as discussed below.

With passbook accounts, all deposits, withdrawals, and other transactions are recorded in a book that the depositor holds and presents with each transactions. (Passbook account transactions are, of course, also recorded by the bank’s computers). Before the advent of computers, this was the standard type of savings account. Some consumers still prefer the passbook account—perhaps because it represents tangible evidence of their savings balance—even though the passbook are easily lost or misplaced and passbook depositors do not have access to automated teller machines. (Some banks no longer even offer passbook accounts.)

The statement account is identical to the passbook account except that transactions are recorded solely by the bank’s computer except that transactions are recorded solely by the bank’s computer and the depositors receives a monthly or quarterly statement—often combines with his or her checking account statement—itemizing each transaction. Some banks encourage the use of statement accounts by offering slightly higher rates or giving the depositors access to automated teller machines.

Advantages
Aside from safety, the sole advantage of either type of savings account is that your money is always available—moments after you make a cash deposit into a statement account and at any time, day or night—through an ATM. In addition, since there is normally no limitation on either frequency or amount for deposits or withdrawals, it is a convenient place for the deposit of small checks as well as for the periodic withdrawals of small amounts of money. It may also be a convenient place for a child’s first savings or for a custodial account for minors, to which you plan to make periodic additions until it grows large enough for a higher-yield investment.
If your bank links a savings account with a checking account that pays no interest, you may find it worthwhile to keep most of your funds in the savings account and make transfers to the checking account only when its balance needs replenishing.

Interest and Fees
Although there no longer are any restrictions on the interest banks can pay, few if any of them have raised the earlier ceilings of 5.25 or 5.5 percent, and some pay an even lower rate. In addition, approximately 75 percent of banks have established a minimum balance requirement—between $25 and $400—and pay no interest on the account balance if it falls on below the minimum. Some banks, moreover, have instituted monthly or quarterly account-servicing fee of $1 to $2, which further erode the interest you are likely to earn.

The method by which interest is compounded—quarterly, monthly, daily, or continuously—makes an insignificant difference. On a $1,000 balance, for example, monthly compounding at 5 percent interest would, at the end of a year, yield $51.16, whereas continuous compounding would yield $51.27.

Far more important than the frequency of compounding is the method used for calculating the interest. Whether the bank uses a 366, 365 or 360 a day year in computing interest is insignificant but the balance on which the interest is computed can influence your yield considerably. Some banks pay interest only on the lowest balance in your account during the month. Thus, if your balance since July 1 has been $1,500 but you withdraw $1,000 on July 29, your interest for July will be based on only $500. Before the advent of computers, banks used the low-balance method because it was easier to calculate. Computers are now able to handle interest payments on the basis of a daily balance, but some banks retain the old method to discourage small amounts.

Yield
Bank advertisements, whether for savings accounts, money market accounts, or certificate of deposit, often quote two figures: the annual interest rate and the effective yield, a slightly higher figure. The difference between these two figures stems from the frequency with which interest is credited to your balance and thus increases the principal on which subsequent interest is paid. A 5 percent interest rate will have an effective yield of 5 percent if the interest is credited annually, but its effective yield will be 5.094 percent if interest is credited quarterly and 5.116 percent if interest is credited monthly. This difference, too, is trivial unless the balance is very large (but, as we shall see, a savings account is no place for a large balance).

Is A Savings Account Worthwhile?
Before the opening a savings account, you need to inquire about the interest rate, any minimum-balance requirements or service charges, and the method used for computing interest. In addition you should inquire about similar accounts in a credit union, which generates pays significantly higher rates than a bank.

Regarding any savings you invest, especially in a regular savings account, it is important to recognize the effects of inflation. If the inflation rate is a relatively low 5 percent and you deposit $1,000 in a 5 percent savings account that is compounded monthly, you will as we have seen, have earned $51.16 at the end of the year. If you are in the 28 percent tax bracket, you are likely to pay about $14 in taxes on this interest. In real terms, then, your $1,000 will have increased to $1,037 after taxes. But the 5 percent inflation rate has reduced the purchasing power of your $1,037 to only $985—so you have actually lost money on your investment. You have fared only slightly better than you would have by keeping your money in your mattress (where inflation would have reduced your $1,000 to $950). Because neither interest rates nor the rate of inflation can be predicted, there is no alternative investment that can guarantee you a gain that is not eroded by inflation. But investments with a higher yield obviously are better than those with a lower yield.

Having recognized the disadvantages, you then need to ask yourself whether the convenience offered by a savings account is worth the difference between its yield and a higher yield you might earn with no loss of safety.

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