SAVINGS ACCOUNT

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SAVINGS ACCOUNT

Published by sam - 28/08/07 - 08:08:37 am

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Savings may be defined as the money that you set aside from your disposable income for future use instead of spending it immediately. The future use you anticipate may occur at the end of the month, when your mortgage payment falls due, at the end of the year, when your need to buy a new car, or 10 years from now on, when your child’s first college tuition bill. You may intend part of your savings to protect you against an unspecified rainy day –to pay for unforeseen emergencies like medical expenses or the loss of your job or to allow to take a vacation or redecorate your home.

Whether you are saving for the short term or the long, however, you should be concerned with three factors. You want your savings to be protected against total or partial loss; you want them to grow by earning interest; and you want them to be readily available.

Unfortunately, there is no investment that will simultaneously satisfy your concerns for safety, yield, and liquidity. Whether you invest your money in a savings account, stocks, or real state, the higher the safety, the lower the yield, typically—and the higher the yield, the lower the liquidity. This is why bank savings account, for example, which are both safe and liquid, offer lower yields than money market mutual funds, which are marginally less safe but as liquid. That is also why money market mutual funds yield perhaps one-fourth (in some cases) of what you might earn from an investment in real state, whose return is less assured and substantially less liquid.

The reasons for these triangular relationships are clear enough. Banks need deposits so that they can lend their depositor’s money to loan customers and earn the difference between the interest they pay depositors and the much higher interest they charge borrowers. Because banks want to have long term deposits that they can count on, they pay a higher rate for long term certificates of deposit, which may carry penalties for early withdrawal, than they do for savings account deposits, which can be withdrawn at any moment. Because most banks have Federal Deposit Insurance Corporation (FDIC) coverage, they can pay less interest than money market mutual funds, which have no such insurance coverage and are the oretically less safe. Since the cost of maintaining a customer’s account is virtually the same regardless of the balance, banks pay a higher yield on large balances less than on small ones.

HOW MUCH LIQUIDITY DO U NEED?

Many consumers fail to realize the full earnings potential of their savings because they overestimate their need for liquidity and safety. Today the balance in the typical bank market account—a safe and highly liquid form of savings ranges from $10,000 to $18,000, a sum far greater than most people actually need to keep liquid, because large expenditures almost always involve long-range planning. A large portion of such a balance could be invested to produce a much higher yield with only slightly less safety or liquidity.

Your first step in planning your savings strategy, then, is to estimate how much money you are likely to need in the near future, bearing in mind that some of the emergencies you anticipate—for example, sudden hospitalization or the total destruction of your automobile—are likely to be covered at least in part by insurance and will probably not require a next-day or even a next week layout of cash. If you have sizable amount of savings, you may want to put some into a regular savings or money market account, each of which has immediate liquidity, some into a three month certificate of deposit, which has lower liquidity but a higher interest rate; and some into one year certificate of deposit, which has a still higher interest rate. You may also want to consider investments discussed in chapters 17 through 22, which offer a far wider range of safety thrift institution can offer.

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August 28, 2007 | Savings Accounts, Banking |

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