There are several advantages to savings accounts. Savings accounts pay interest, allow for easy access to your money, and offer a low minimum balance amount. Savings accounts can help you budget your finances and save for your financial goals. With a wide variety of interest-accruing accounts on the market, what type of account offers the best return? Savings accounts are often the first resort since they offer many features and benefits. However, savings accounts come with both advantages and disadvantages. Here’s a look at some savings account pros and cons, along with four alternatives that might be better than a savings account.
Savings Account Pros and Cons
Pros of Savings Accounts Explained
Earn interest: One advantage to savings accounts is that they often pay interest on the money you deposit. Traditional savings accounts typically offer a modest annual percentage yield (APY), while online-only savings accounts may pay higher APYs—sometimes 10 times as high as a traditional account. Easy to open: Savings accounts are often easy to open. In many cases, you can apply and complete the process online within a few minutes. Accessible funds: Another positive feature of savings accounts is that they provide easy access to the funds in your account. The money stays liquid and isn’t subject to a specific term like it is when it’s in a certificate of deposit (CD). You can often manage your money online and schedule transfers or withdrawals as needed (although withdrawals may be limited). FDIC-insured: The money in your savings account will be insured for up to $250,000 as long as you choose a federally insured bank or credit union. That means if the institution goes bankrupt, your money won’t be lost. Low risk: Savings accounts are safe, low-risk investments that offer returns without the concerns of losing your money. Other types of interest-earning accounts require you to take risks to earn returns.
Cons of Savings Accounts Explained
Fees: One of the disadvantages of savings accounts is that some financial institutions charge fees that can defray your earnings. For example, a monthly fee may be charged if your balance drops below the minimum balance requirement for the account. Low APYs: With the low risk of savings accounts comes low-interest rates. Compared to other interest-yielding options like CDs, savings accounts will often have lower APYs. No tax benefits: The interest you earn from your savings account is taxable in the year it’s paid. Account restrictions: Savings accounts often have restrictions, such as minimum balance or deposit requirements, withdrawal limits, and limited deposit or withdrawal methods. For example, to get a certain APY, you may need to deposit a minimum amount in the account. Further, you may be limited to six penalty-free withdrawals per month. FDIC insurance is limited: If you plan to keep more than $250,000 in an account, any amount above $250,000 won’t be protected by federal insurance.
Savings Account Alternatives
While savings accounts offer several features and can be a good place to start, other types of accounts might be better than savings accounts. Here are some alternatives to consider.
Money Market Accounts
A money market account (MMA) is another type of savings account offered by banks and credit unions that is often insured by the federal government up to $250,000. MMAs are known for higher APYs and minimum balance requirements than traditional savings accounts. However, some high-yield savings accounts are now beating MMA rates without requiring such high balances. According to an FDIC report from June 2022, the average APY for MMAs is about equal to the average APY for traditional savings accounts.
Certificates of Deposit
A certificate of deposit (CD) might be better than a savings account if you don’t need immediate access to the money. A CD is a type of savings account where you deposit a specific amount of money into the account for a set term to earn the APY. For example, a 12-month CD with a 0.14% APY would require you to keep the money in the account for 12 months to earn the interest. Typically, the longer the term, the higher the APY. However, if you withdraw your money early, you often have to pay an early withdrawal penalty or forgo your interest earnings. While longer CDs may offer higher returns than a savings account, you’ll need to leave the money in the account for the full term to reap the benefit.
Low-Risk Bonds
Government bonds can be better than a savings account since the interest paid is usually higher, depending on the type of bond. Putting your money into U.S. Treasuries or municipal bonds is riskier than stashing it in a savings account, but it’s still relatively safe compared to investing in other kinds of bonds due to government backing. However, there are risks with bonds if you sell them before their maturity date. For example, a U.S. Treasury security guarantees the initial investment amount but only if it’s held until maturity. In other words, if you sell the bond before it matures, you could take a gain or loss depending on the purchase and sale prices. Treasury bonds pay a fixed interest rate every six months until they mature, and are issued in terms of 20 or 30 years. These can be purchased through the U.S. Treasury Department website or from a bank, broker, or dealer. Municipal bonds, which are issued to finance the daily obligations or capital projects of a city, county, or state government entity, allow you to lend money to the issuer in exchange for regular interest payments. The bond’s maturity date depends on its duration; short-term bonds mature in one to three years, while long-term bonds often won’t mature for more than a decade. Interest rates on municipal bonds fluctuate; however, they generally follow the broader bond market.
Peer-to-Peer (P2P) Lending
The popularity of peer-to-peer lending platforms translates into a unique opportunity for you to earn a higher rate of return on your money than you would in a savings account. These sites match individual borrowers with individual lenders and offer accounts for investors that can be opened with as little as $25. Your investment will be used to fund personal and business loans, with yields that can range into the double digits, depending on the risk profile of the borrower. The rate of return should be factored in with the risk—these are unsecured loans—but they can be a good alternative to a savings account.
How To Use a Savings Account
A savings account is often a good first step when you start saving money. It’s safe and is a good place to build an emergency fund. If you decide a savings account is right for you, be sure to shop around to find the one that’s best for your situation. Look for savings accounts with minimal fees, a good interest rate, a low minimum balance requirement, and solid customer service. Once you have a six-month emergency fund in place, it can be advantageous to diversify. Explore other savings vehicles that offer a higher rate of return, but might be less liquid or riskier. In addition, you may opt to put an additional portion of your income toward retirement savings in even riskier investments that have much more upside potential. With time on your side, stocks, bonds, and mutual funds in tax-advantaged accounts such as a 401(k) or Roth IRA can yield tax benefits now with the potential for greater distributions in the future. Before 2020, federal law restricted savings accounts to six withdrawals per month, but that’s been put on pause since the pandemic began. Another difference is that savings accounts usually pay interest while checking accounts typically do not.
