BANKING

Savings Vehicles

Banking

Earlier, we pointed out that you're best off only keeping enough in your checking account to pay the monthly bills and avoid low-balance fees. Beyond that, you should aim to get the best rate of interest available for your intermediate-term savings, and that means putting some of your extra cash somewhere other than a checking account. (As you've probably heard us preach elsewhere on this site, we like individual stocks for money that you're socking away for at least five years.)

Millions of Americans today are going about this the wrong way, and settling for very low yields on their savings. Today there is more money deposited in savings accounts yielding 2% than there is in certificates of deposit (CDs) yielding an average of closer to 5%. Nearly $1.5 trillion is tied up in accounts that aren't paying any more than 2%. That needs to change, and, as usual, the best way to beat the system is to learn more about it.

There are essentially three types of savings accounts:

Passbooks. Do people still use these? Apparently some do. If you're a late Generation Xer or older, you probably remember a type of account where the bank gave you a little book to record your transactions. By law, these accounts paid 5% interest until 1986, when deregulation allowed banks to set the rates. Guess what? The banks set them lower, and today they've drifted all the way down to about 2%, maybe less if you're banking with one of the big national banks.

Statement savings. You can tell this account from a passbook account only by the fact that there's no passbook -- there's a statement sent monthly in the mail. The interest rate for statement savings accounts is about 2%.

Money Market Accounts (MMA). Money market accounts are savings accounts offered by banks and credit unions that pay out a slightly higher rate on your money -- about 2.5% on average. (The Foolish shopper, however, will be able to find MMAs with roughly double that rate of return by doing a little research. Check Bank Rate Monitor for the most recent national rates as part of your research.) MMAs may require a higher minimum balance, but you can make as many deposits as you like for free and you can write up to three checks per month. Plus, they're insured by the Federal Deposit Insurance Corporation (FDIC -- Ask about dollar limits on the insurance to make sure your money is protected).

Money Market Funds (MMF). Money market funds are a type of mutual fund. Though not government insured, they are very secure since regulations require these funds be invested in high-quality, short-term investments like short-term loans to corporations or government agencies and U.S. Treasuries. Currently, money market funds can snare you nearly 5%. Again, shop around for the best rates.

Certificates of Deposit (CDs). Going beyond the above accounts, if you have money that can stand to be tied up for anywhere from three months to six years, certificates of deposit will offer even higher rates -- currently slightly higher than a 5% APY. Of course, if you're putting money into CDs, remember that the longer the term, the higher the interest rate you'll get -- but you also can't touch that money for the length of the CD term. There is a penalty for early withdrawal of funds, so be careful about the CD you choose. If you're likely to be dipping into some of that money to fix the house, take a vacation, or buy holiday presents, don't put too much into a long-term CD. Like savings, checking, and money market accounts, CDs are FDIC insured for up to $100,000.

Know How Interest Rates Are Calculated

When advertising interest rates on any of these types of accounts, banks may use two different numbers: Annual Percentage Yield (APY) and Annual Percentage Rate (APR). APY is used for savings and CD accounts, while APR is used for loan accounts such as credit cards.

A rate is simply what an account earns before any interest is added. More important than the rate is the yield. A bank might quote rates that are compounded daily, weekly, monthly, quarterly, or yearly, and each will produce a different yield -- the more frequently the rate is compounded (the adding of interest to interest), the higher the yield. The yield is what the account actually pays you in one year, after all the interest is added to the original amount deposited. Over the course of a year, interest that's compounded yearly could produce a lower yield than a lower rate that's compounded daily, and so the APY is the number you need to know to truly compare one bank's offering with another's.

The rate, or APR, will always be a lower number than the APY, which is why credit card companies advertise the APR applicable to credit card balances.

Always remember to get the APY for CDs, money market accounts, or savings accounts rather than the APR so that you're comparing apples to apples.

It's Not Just the Interest Rate, Fool

If you've got a checking account set up somewhere, and you wish to have that account be local (either because you want to have a local branch you can walk into, or you enjoy being able to use its large local distribution of ATMs), you should still consider moving your intermediate-term savings into an out-of-state bank (if necessary) for the very best rates on CDs or money market accounts. If you're limiting your savings to what your big local bank is offering, you're almost surely passing up about an extra 2% earnings on your savings.

Why is it that a small bank you've never heard of halfway across the country can offer much better rates than that gigantic ThirdUnion that just swallowed up half the banks in your area? It's because the tiny thrifts and savings banks don't have to maintain so many branches, pay so many employees, and buy so much commercial time that they can afford to make their customers' money actually work for them.

But keep your eyes on the fees -- always. If you're setting up any accounts out-of-state, in-state, or in cyberspace, keep in mind that the highest interest rates may very well be accompanied by some extra fees. Make sure that when you're shopping around you get the fee disclosure forms from all the banks you're considering. Again, get your past bank statements and compare your behavior to the fees that each bank charges.

There will, of course, be numerous other questions that you will want answered before finally deciding which bank gives you the best bang for your buck, but the best account is very likely not at the bank that has the most commercials or the one that has just swallowed up your old bank. Although these large regional, super-regional, or national banks might have the most ATMs in the area, and that might lead you to believe that is what's most important, have you really been keeping an eye on what's going on with ATMs lately? And what you're using them for? If not, it's about time you did.

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