Should I Open a Savings Account and Why?
EG
Summary:
A savings account can be an excellent way to build your emergency fund and save for financial goals, all while earning a return on your savings. That being said, there are some downsides to savings accounts as well. Depending on your financial goals, for instance, you may find it best to put some money into a brokerage account where it could potentially earn higher returns than a savings account.
Maybe you’re saving money for a major financial goal, such as a down payment on a home or an upcoming vacation. Or perhaps you’re just starting to build your emergency savings. Either way, you’ll need a safe place to store those funds where you won’t be tempted to spend them on anything else.
That’s where a savings account comes in. In this article, we’ll talk about the various benefits of savings accounts, a few drawbacks, and whether you need one.
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Should you open a savings account?
The short answer is that yes, you should open a savings account. First, a savings account makes it easy to separate your savings from your day-to-day spending money, making it easier to commit to your financial goals. Savings accounts have the added benefit of offering a return on your savings in the form of interest from the bank or credit union.
How savings accounts work
A savings account is a type of deposit account offered by many banks, credit unions, and other financial institutions. You can open an account and store money there, and the bank will then use those funds to make loans to other bank customers. In return, you’ll earn a small interest on your savings balance.
Traditional savings account interest rates are so low that you may not think it’s worth it to open an account. But many institutions— especially online banks — now offer high-yield online savings accounts. These accounts offer a higher interest rate, usually one that’s based on the current federal funds rate.
Savings accounts are generally designed for the money you don’t plan to use in the near future. As a result, you usually can’t access the money in these accounts using a debit card or ATM. Instead, you usually must visit a bank or credit union branch to make a withdrawal or transfer the funds to your checking account. You’re also limited by the Federal Reserve to just six withdrawals per month.
Money market accounts
Another kind of savings account is a money market account. This account offers higher interest rates than most savings accounts, sometimes reaching above 1.5%. Though you may see similar returns with a high-yield savings account, money market accounts can also come with a debit card feature that allows you to withdraw funds directly from your account. Depending on your spending habits, this can be both a good and bad thing.
If you prefer these features to an online savings account, start by comparing the money market accounts below to open an account.
Benefits of a savings account
There are plenty of benefits to savings accounts that make them worth it for just about anyone. Below we’ll talk about some of the biggest advantages of these accounts.
You can earn interest on your savings
Perhaps the biggest thing that sets savings accounts apart from other deposit accounts is your ability to earn interest on your savings. While you certainly won’t get rich from the interest you earn on your savings account, you can earn a bit of extra money each month, which can go toward your financial goals.
Let’s say you have $10,000 in your savings account and an annual percentage yield (APY) of 1%. After the first year, you would have earned $100 in your savings account, which is a little over $8 per month.
But one of the perks of a savings account is that interest compounds. So in the second year, you aren’t just earning interest on your original $10,000 balance. Instead, you’re earning interest on the $10,100 that’s now in the account.
You’ll have money for an emergency
One of the most important parts of becoming financially healthy is having an emergency fund in place, which can be used to cover an emergency expense or to replace your income if you lose your job. Experts generally recommend having at least three to six months’ worth of living expenses in your emergency fund.
Unfortunately, the most recent data shows that about one-third of Americans don’t have enough savings to cover a $400 emergency expense. Instead, these expenses are often put on a credit card. And because of the high interest rates on credit cards, a single expense can often end up costing hundreds of dollars more. Luckily, having an emergency fund in place can help you avoid going into additional debt.
You can save for financial goals
Your emergency fund isn’t the only financial goal a savings account can help you reach. You can also use your savings account to save for any other goal, big or small, such as the down payment on a home, an upcoming vacation, college tuition, and many more.
You can avoid the temptation to spend
We all know how big the temptation to spend can be, especially when it comes to avoiding FOMO or keeping up with friends and family. And it’s even easier to spend money earmarked for savings goals when it’s in the same account as your spending money.
That’s where a savings account can help. Rather than being able to spend your savings with the swipe of a debit card, you have to go through the additional steps of transferring the money to your checking account first. And with the money sitting in a separate account, you may forget about it altogether, further eliminating the temptation to spend it.
Pro Tip
It may be worth keeping your savings at a separate financial institution. It will be more difficult to access and, therefore, more difficult to spend impulsively. To find the best savings account for your money, use our comparison tool below.
You can keep your money safe
A savings account is a safe place to store your money, and not just because it’s harder for you to spend that money. The money in savings accounts is insured by the Federal Deposit Insurance Corporation (FDIC), meaning if your bank goes bankrupt or out of business, the FDIC will replace your lost funds.
FDIC insurance covers $250,000 per person per institution for each ownership category. So if you have an individual checking and savings account with the same bank, you’ll have a combined $250,000 of protection. But if you also have a joint account, another $250,000 of protection will apply for that account.
Drawbacks of savings accounts
Savings accounts have some major advantages, but we’d be remiss if we didn’t mention their downsides as well.
More difficult to access
One of the disadvantages of savings accounts is that it’s more difficult to access your money. When you have money in your checking account, you can spend it at any time using your debit card. But with a savings account, your money is a bit more difficult to access.
You generally have to transfer the funds to a checking account or visit a bank branch to make a withdrawal. And if your savings account is at a separate bank or credit union from your checking account — which is often the case, since online savings accounts offer the best interest rates — then it can take several days for the transfer to go through. This probably isn’t a problem in most cases, but it could be in a financial emergency.
Limited withdrawals
In addition to limited access to your money, you’re also limited in the number of withdrawals you can make. Federal regulations limit account holders to making just six transactions per month from their savings accounts. If you’ve already met that limit, you may not be able to access your money.
Low interest rates
The other downside of savings accounts — and perhaps the most important downside — is their low interest rates. Savings accounts earn notoriously low returns. Even with interest rates rising, many high-yield accounts are just around 1%.
Low rates are even more problematic during periods of high inflation. To illustrate, during the 12 months from May 2021 to May 2022, inflation rose 8.6%, so anybody with money in a savings account paying 1% APY effectively lost 7.6% because their savings were not keeping up with inflation. Even in years with “normal” inflation (e.g. around 2%) your money is still losing value if your savings account APY doesn’t at least match inflation.
For your emergency savings and short-term financial goals, taking a low interest is typically worth it because of the liquidity and “security” a savings account offers. After all, you may not want to risk losing that money in the market. But for longer-term financial goals, such as those five or more years away, your money may be better invested in a brokerage account where you can earn a higher return.
How to open a savings account
Opening a savings account is easy, and can usually be done in as little as a few minutes. Here’s how to get started:
- Choose the right account. When deciding where to open a savings account, consider the APY, minimum account balance requirements, and whether there are monthly maintenance fees.
- Provide the required documents. You’ll usually need a form of identification, including your driver’s license and Social Security number. You’ll also have to provide contact information, such as your address and email address.
- Submit an application. Depending on the bank and your financial situation, the bank may approve your application right away or may need a few more days to consider it.
- Fund your account. Once your application has been approved and your account is open, link a checking account or another payment method to fund your account.
FAQs
Is it worth it to open a savings account?
Yes, it’s worth it to open a savings account. Not only can you save for emergencies or your financial goals, but you can accumulate interest earnings while doing so.
Are there downsides to opening a savings account?
There are a few downsides to opening a savings account, including the low interest rates and the fact that your money is a bit more difficult to access. You’re also limited to six withdrawals per month, and it may take a few days to transfer funds from your savings account to your checking account.
How much money should you keep in your savings account?
Generally, you should keep enough in your savings account to cover three to six months’ worth of expenses in the case of a job loss or financial emergency. This should be in addition to the money set aside for any other financial goals.
However, you should avoid keeping too much money in savings. Because of the low interest rate on savings accounts, excess funds may be better invested in a brokerage account.
Key Takeaways
- A savings account is a type of deposit account offered by financial institutions that allows you to earn interest on your savings.
- Benefits of savings accounts include your ability to earn interest, the reduced temptation to spend the money earmarked for other goals, and FDIC insurance.
- Downsides of savings accounts include interest rates that don’t keep pace with inflation and the fact that it’s more difficult to access your money.
- To open a savings account, you’ll need to choose the right account, provide the necessary documentation, submit an application, and fund your account.
Related reading: Now you know that you likely should open a savings account. The next question is obvious. “How many savings accounts should I have?” you ask. Click your question to find the answer.
EG
Erin Gobler is a Wisconsin-based personal finance writer with experience writing about mortgages, investing, taxes, personal loans, and insurance. Her work has been published in major outlets, such as SuperMoney, Fox Business, and Time.com.
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