There are many different types of bank accounts where you can keep your money, and each one serves a different purpose. It’s important to know what accounts are available to you to allocate your money based on your short-term goals properly.
The three most common bank account types are:
- Checking accounts
- Savings accounts
- Certificates of deposit (CDs)
|Account Type||Used for|
|Checking account||Everyday transactions – paying bills, ATM withdrawals, receiving your paycheck|
|Savings account||Short-term goals – rainy-day fund, vacation, and will earn you a small amount of interest|
|Certificate of deposit (CD)||A locked-in amount of money that earns you interest for a fixed period|
What is Liquidity?
An important term to know before comparing different bank account types is financial liquidity. Liquidity refers to how easily an asset can be converted into cash. Cash is the most liquid asset because you can immediately use it to pay for a good or service. Other assets which may take longer to convert to cash are less liquid.
A checking account is the most liquid type of bank account, as you can make a purchase instantly with it, or you can withdraw your money from an ATM and have it immediately. With a savings account, it generally takes 2-5 business days to transfer money between different accounts, especially when the accounts are with different providers, so a savings account is not as liquid. The certificate of deposit is the least liquid out of these three options. You must keep your money in the account for a fixed period of time. Otherwise, you will be charged a penalty fee.
What are Interest Rates?
When you put your money in a bank account, you are essentially loaning your money to the bank. For instance, with a savings account, the bank is a borrower, and you are the lender. The money you put in your savings account can be thought of as a loan. The interest rate is the amount of money the borrower (bank) pays the lender (you) on top of your loan. Typically interest rates are noted annually and are referred to as the annual percentage yield (APY). For example, if the stated APY on your account is 0.5%, and you have $1,000 in your account, you should expect to earn $5 in interest over a year.
Why do interest rates matter?
Many savings accounts offer high-interest savings options, which pay much more than the national average of 0.04%. You should look for a savings account with competitive interest rates to maximize your return over time. Beware of promotional offers or marketing ploys by companies who pay a higher interest rate for a short period of time when you first open your account, and then they drop it below market rates.
The nation’s largest banks often pay below market interest rates. They typically have such a large customer base that they do not need to create added incentives to hold people’s money. In contrast, online banks are often an excellent choice for savings accounts as they can pay you higher interest rates as they do not incur traditional expenses such as rent or overhead that physical bank branches do.
What do banks do with your money?
While you are loaning your money to the bank you chose to use, you may not know what they actually do with this money. Many banks are using your money to finance their business dealings. Often, this means they are using your money to fund the climate crisis. In fact, over the past five years, 60 of the world’s biggest banks have financed fossil fuels in the amount of $3.8 trillion. While it is not widely advertised, it is essential to do some research to make sure your bank is spending your money in a way that aligns with your values. Take a look at where your current, or potentially future, bank stands here.
- 1. Checking account
The most basic and well-known account type is a checking account. A checking account is an account where you can easily access your money and is commonly used for everyday spending. The main feature of a checking account is that it is linked to a debit card. A debit card can be used to make purchases or to withdraw cash from ATMs. Many people use their checking account to receive their paycheck or to pay their bills.
Every checking account can have different fees for actions such as ATM withdrawals, transfers, or minimum balance violations. It’s good to compare a few options before deciding which provider is best for you based on your lifestyle. A few features to look for in a checking account are:
- Online banking features
- No minimum balance required
- No monthly fees to maintain the account
- Direct deposit
Checking accounts generally carry minimal interest (>0.05%), if any at all.
– Set up autopay for your bills to avoid late fees.
– There are many providers for checking accounts nowadays, and they have competitive offerings – look for the one that offers you the most flexibility and will not charge outrageous fees for the things you will need most
- 2. Savings account
A savings account is a safe place to save up money you may need in the short term (think one year or less). Savings accounts earn interest and keep money easily accessible. Because of this, a savings account is the perfect place to build your rainy-day fund or for saving for a short-term goal like an upcoming trip or a purchase like an engagement ring. Unlike a checking account, a savings account doesn’t typically come with a debit card.
Savings accounts generally have more limitations than checking accounts, such as how many withdrawals you can make per month or the number of transfers allowed. Every savings account offers different interest rates, fees, etc. It’s good to compare a few options to see which one is best for you and which one can offer you the most.
– Create different buckets for your money in your savings account so you can keep track of the different goals you are saving for in the short term.
– Look for a high yield savings account that offers competitive and consistent interest rates throughout the year
- 3. Certificates of deposit (CD)
A CD is an account linked either to your checking or savings account that will hold your money for a fixed period of time. A CD can earn you more interest than a checking or savings account, but you must keep your money in the CD for the entire period of time. If you take your money out before the full term (also known as the maturity date), you will be hit with an early withdrawal penalty. The term lengths of a CD can vary from short-term (12 months or less), mid-range (1-3 years), or long term (4-5 years)
A CD is good for money you will not need to spend immediately and will be comfortable putting away for a fixed period of time. Essentially, a CD is a loan to the bank, and since you create a time frame around this loan, you are rewarded with a fixed interest rate. However, if you are considering a CD, you need to check the interest rate so you do not lock your money away with a lower rate than inflation. Once it is locked away, you will be unable to touch it without incurring fees.
Keep in mind all of these bank account types are suited for short-term cash management purposes. When thinking of the short term, you should think of anything in the next year. These accounts are generally not suitable for long-term goals, such as buying a home in a few years or saving for retirement.
- Key Takeaways
- You shouldn’t use your checking account to store money for your long-term goals
- Make sure your savings account pays a competitive interest rate
- Check the interest rate on your CD to make sure you are not losing money over time due to inflation