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Why Do People Save Money?
People save their money for a variety of reasons. The most common reason is to save for emergencies. Everyone, even teenagers, should have at least some savings for emergencies. Financial experts suggest adults should have about six months of expenses saved for emergencies.
If your expenses are $1,000 per month, how much should you have in emergency savings?
You may have heard some people who keep their emergency savings stored somewhere in their house, often a mattress. Do you know why people do that? It's because during the Great Depression in the 1930s, people didn't trust the banks, and felt their money was safer in a mattress. Can you imagine some of the dangers of having $6,000 in your house? If your house catches on fire you would lose all your money. And, your house would be a target for robbers if they suspected you had money stored somewhere.
Since then, the US Government has put policies in place to make people more confident in the banking system, such as the FDIC Federal Deposit Insurance Corporation , which protects deposits up to $250,000. So, even if your bank somehow lost all its money, the Federal Government would step in and ensure that you got your money back.
Today, the most common reasons people save their money are
- for emergencies;
- for something specific such as a new car, house, college education, vacation, or make a repair or improvement to their house,
- to avoid spending it.
Can you think of any others?
There are three main types of savings accounts:
- Traditional savings accounts,
- Money market accounts, and
- Certificates of Deposit (CDs)
Savings Accounts
When most people think about saving money in a bank or credit union, traditional savings accounts are what spring to mind. If you have a savings account, more than likely you have a traditional savings account.
Main characteristics of traditional savings accounts
- Where to get one: Your local bank or credit union
- Minimum balance: Usually low
- Interest rate: Very low - often the lowest of all saving and investment strategies
- Compounding: Most savings accounts are compounded daily, which is ideal
- Limits: Many banks limit the amount of withdrawals each month
- Fees and penalties: If you exceed the limit of withdrawals
- Risk: Savings accounts are insured by the FDIC, however, there is inflation risk when the price of goods and services rises faster than the interest rate you are earning
Money Market Accounts
A money market account is a type of savings account that earns a higher interest rate than a traditional savings account, but usually requires a higher balance, and often earns more money the higher the balance.
Main characteristics of money market accounts
- Where to get one: Your local bank or credit union
- Minimum balance: Higher than traditional savings accounts
- Interest rate: Low - but usually higher than a traditional savings account
- Compounding: Most money market accounts are compounded daily, which is ideal
- Limits: Many banks limit the amount of withdrawals each month
- Fees and penalties: If you exceed the limit of withdrawals
- Risk: Money market accounts are insured by the FDIC, however, there is inflation risk
Certificates of Deposit (CDs)
Certificates of Deposit, which are also known at CDs, are similar to savings accounts, but they have a few critical differences. First, CDs usually earn a higher rate of return than savings accounts, but they come with a catch; you can't touch them for a certain time period. CDs come in various lengths, from 6 months up to 5 years.
Main characteristics of CDs
- Where to get one: Your local bank or credit union
- Minimum balance: Usually low
- Interest rate: A little higher than savings accounts
- Limits: Cannot withdraw until maturity date the date at the end of the term of the the CD
- Fees and penalties: Large penalty for withdrawing early
- Risk: Certificates of Deposit are insured by the FDIC, however, there is inflation risk. Also there is the risk that you may need your money sooner than the term on the CD.
