Let’s be honest, when it comes to savings accounts, the low interest rates you are bound to run into can be a little underwhelming. So, when you look around and see a variety of higher-interest options, it’s easy to start wondering why we bother with them at all. So, what’s the point of a savings account?
The purpose of a savings account is to hold your money in a secure location that earns you a little bit of interest. Unlike checking accounts, you cannot spend money directly from a savings account. Therefore, savings accounts help restrict your chances of spending money impulsively and increase your financial preparedness in case of an emergency.
For the rest of this article, my goal is to equip you with a solid understanding of savings accounts, and the role they play in personal finance.
Let’s dive in!
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The Purpose Of A Savings Account
Let’s get something out in the open right now: the purpose of a savings account is not to build wealth. Sure, when you put money in there, it will increase your net worth, but savings accounts with low interest rates do not make good investments.
Rather, they are there to provide you with a spot to keep some money for reasons other than investing. In fact, a healthy savings account is one of the best ways to protect your investments.
Think about it, if you were to move all your money from savings, and invest it, how would you pay for an unexpected, or emergency expense? First of all, you would have to pull money out of your investments (which is a slippery slope), and second of all it could take time to sell.
A savings account gives you a place to maintain liquidity in your financial life.
In essence, a savings account is good for protecting your investments, preparing for emergencies, and peace of mind in your financial life.
5 Reasons To Open A Savings Account
In personal finance, I am all about keeping things simple. Which is why, in a previous article, I talked about opening multiple savings accounts in order to make budgeting easier. When you have different savings accounts that serve different purposes, it simplifies, and adds clarity to your financial life.
And that is one of the most important roles that savings accounts can serve in your life.
So, with that in mind, here are five simple reasons to open a savings account.
Emergencies
If for no other reason, you should have some sort of savings account that can cover you in case of emergency expenses. Some people call this a rainy day fund, while other people just call it an emergency fund. Regardless of what you call it, we recommend that you keep six months worth of expenses in this account.
Saving an emergency fund is something just about everybody wants, but very few people actually make a point to do. When it comes to emergency funds, it’s better to have one and never need it, than to need one and not have it.
Automotive
One thing I can tell you about cars, is that they aren’t cheap to maintain, and they aren’t cheap to purchase. So, if you want to be prepared for the inevitable expenses that come with car ownership, then you might want to open a savings account specifically for automotive expenses.
You see, unlike emergency expenses, automotive expenses are predictable. You need to change the oil every few months, you will need to rotate the tires every few thousand miles, and after enough wear and tear, your car will need some repairs. (That is not a comprehensive list, by the way.)
So, you should save some money each month to prepare for these expenses. And a savings account is a great place to do so.
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Vacations
I love to travel. I haven’t done as much of it as I would like in my life, but that is a major goal for my wife and I. And, if you love to travel too, you should consider opening a vacation savings account.
I’ll admit, there are times that the idea of spending money on a vacation feels a little irresponsible. And that feeling only gets worse when you have to pull it from your one, lone savings account. Whereas, if you pull money for travel from a savings account specifically created for travel expenses, it is guilt-free.
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Home
As a homeowner, opening a savings account for the sole purpose of saving money for home repairs and upkeep can be one of the smartest financial moves you make. Like automotive expenses, most home expenses shouldn’t come as a surprise to you.
For instance, if you live in a home with a brand new furnace, you should probably expect to need a new one about a decade from now. In other words, ten years from now, when your furnace stops working, you shouldn’t have to pull from your emergency fund, because you should be prepared for it.
Holidays, Gifts And Parties
It really bugs me when people say, “Christmas snuck up on me this year!” when they’re talking about their finances. Christmas happens on the same day every single year, so there is no reason you should be unprepared. On top of that, there are birthday gifts you will need to buy every year, holiday parties, and other get-togethers that will cost you money.
That’s why you should consider opening — and consistently contributing to — a savings account specifically for gifts and parties.
How Much Money Should You Keep In A Savings Account?
At a bare minimum, you should keep 3 months worth of expenses in a savings account to cover emergency expenses. Though, if you prefer to err on the side of caution, you should plan to save up the equivalent of six months of living expenses.
Beyond emergency expenses, it is a good idea to save for periodic expenses like automotive costs, homeownership costs, and other predictable expenses in your life.
What Is A Good Interest Rate On A Savings Account?
These days, the interest rates in savings accounts can be appalling. I mean, if you are only making 0.01% in your savings account, you should move your money to either a different bank that offers better interest rates, or a money-market account.
If your savings account is earning less than the annual rate of inflation, then your money is actually shrinking. In general, when you open a savings account, you should look for one with an interest rate somewhere between 1% and 2%.
Is There A Better Alternative To A Savings Account?
When it comes to saving money, the difference between an account that makes 1.5% interest, and one that makes 1.6% interest is so minor that you shouldn’t really be concerned. However, if you can’t find a savings account that earns a decent interest rate, then you might want to consider opening a money-market account instead.
As I mentioned before, the goal with your savings account is to keep money on hand in the event that you need some liquid (cash) reserves.
Look around, and compare savings accounts to money-market accounts. You might find that one is better suited to your needs than the other.
What to Watch Out For When Opening A Savings Account
When you open a savings account, the last thing you want to do is tie your money up in a bad situation. You should keep an eye out for fees, low interest rates, and minimum balance requirements. The last thing you want is to have to dip into your emergency fund, and then get hit with a minimum balance fee.
The goal is to save money, not pay your bank more money.
Can You Lose Money In A Savings Account?
If the interest rate you are earning with your savings account is not keeping up with the rate of inflation, then you are actually losing a little bit of money each year. For example, if you have $10,000 in a savings account that makes 1% in interest each year, and the rate of inflation is 2%, then your money will actually shrink in value by $100.
Is There A Limit On Savings Account Withdrawals?
Per Regulation D set forth by the Federal Reserve, you are allowed 6 “convenient” transfers or withdrawals from a savings account account per month. Convenient transfers include: automatic transfers, transfers initiated by phone, computer or fax machine, transfers for overdraft protection, as well as any transfers made using a check or debit card.
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Final Thoughts
Is A Savings Account Worth It?
Yes, it is worth it to open a savings account. Sure, you can get into the specifics and debate between a money-market account, or a savings account, but the ultimate point is that you need a place to save your money. And that is exactly what a savings account is for.
Now, get out there and save.
