With its ups and downs, pros and cons, 2021 is now history and we start with a clean slate and a fresh start in year 2022. How exciting! We can make this year whatever we want it to be! Picture it! I am not big on new year resolutions but there are some changes that I want to make this year and I bet you do, too.
My blogs last year discussed aspects of getting started with a saving and investment plan—setting goals, taking stock of what you already have, making sure that you have an emergency fund established, and the benefits of diversification, among others. You can access all the blogs in my Bev’s Basics.
Now it is time to talk about your choices for saving and investing, starting with saving. Let’s begin with a quick look at the best places to put money for saving.
SAVING FOR SHORT-TERM GOALS
Banks, Credit Unions, and Thrifts
The main difference between a commercial bank and a credit union is that a bank is a for-profit financial institution, while a credit union is a cooperative and usually nonprofit. Thrifts are also for-profit.
Commercial banks may be owned privately, by a family, for instance, or may be owned by shareholders (investors) and have stock that is publicly traded. Banks are focused on providing a return or profit to the owners or shareholders. They will typically have many locations for customer convenience and offer a wide variety of products and services. Some banks do not have brick-and-mortar locations but operate with an online presence. You would expect online banks to have lower expenses because they do not have physical branches along with the associated costs. That savings might mean greater profit to the owners and/or better deals for customers, or a combination.
Credit unions are owned by the people who use their services, their depositors or members, and return profits to their members in a couple of ways. Credit unions might pay a higher rate of interest than a bank for money you deposit with them or they might charge a lower rate of interest for a loan than those charged by banks.
Thrift institutions are savings and loans and mutual savings banks. They can be organized like a bank (owned by investor shareholders) or a credit union (owned by the depositors), but they are always for-profit. Thrifts typically emphasize consumer lending more than commercial or business lending.
What Are Common Ways to Save?
If you have a short-term goal, need the funds in five years or less, and you want your money to earn interest but do not want the risk that you will lose any of the amount that you save (the principal), a money market account, a savings account, or certificate of deposit are all appropriate. A money market account or savings account is also a good place to park your emergency funds, the money set aside for an unexpected need such as the loss of income due to the COVID-19 pandemic.
Money Market and Savings Accounts
If you choose a money market account, you can expect to easily move money both in and out of the account with few restrictions. Some money market accounts even have check-writing privileges or a debit card, but if you are using this product for saving, you must resist the temptation to use those features until you reach your saving goal. The rate of interest—what the bank, thrift, or credit union pays you for the use of your money—will change from time to time. The interest will be added to your account balance periodically, usually monthly.
A savings account may pay a higher rate of interest than a money market account, and the rate will change less frequently; however, a savings account typically has more restrictions. The number of times you can take money out of the account each year may be limited, for example, and savings accounts have no checks. They may allow access to your money with an ATM card, however. Again, the interest you earn will be added to the account regularly.
Compare the rates of interest and any restrictions before choosing between a money market and a savings account. If the information is not readily available, ask.
Certificates of Deposit
You may also want to consider a certificate of deposit (CD) for saving. A CD is a type of deposit locked in for a specific time, a month to several years, usually with a fixed rate of interest. The interest you earn on a CD should be higher than either a money market account or a savings account because your money will not be accessible without a penalty until the date the CD matures. The maturity of the CD is set at purchase; therefore, CDs are good places to put funds if the money will be needed in a specific month or on a specific date. For example, imagine that your grandmother gave you $1,000 for your birthday, and you intend to use it for a vacation trip in one year. Thanks, Granny! You want to put the gift in a safe place where you will not be tempted to use it for anything else, so you decide to purchase a $1,000 face value CD for one year. The best rate of interest that you find for a one-year CD is 1.50%. At maturity, you will receive $1,015: the principal or face value, $1,000, plus the interest earned, $15. Some CDs pay interest more frequently, so be sure to ask.
Even though I do not recommend combining money set aside for saving and money set aside for investing, you may be able to earn a higher rate of interest on a CD purchased through a brokerage account, which is an account normally used for investing. There are important differences if you do, however.
Should I Purchase a CD Through a Broker-Dealer?
First, broker-dealers do not issue CDs; they sell CDs issued by banks or thrifts. Insurance coverage is provided by the CD issuer—the bank or thrift institution. For insurance coverage, it does not matter if you buy the CD directly from the bank or if you buy the CD through a broker-dealer. The ownership rules for insurance coverage still apply.
If you purchase a CD through a broker, the broker may charge you a transaction or other type of fee. Why? Since brokerage firms do not issue CDs but instead sell CDs issued by banks and thrift institutions from all over the U.S., a transaction fee or handling fee is how the broker-dealer covers its costs.
What If I Need My CD Money Before Its Maturity?
There is another difference between CDs purchased through a broker-dealer and those purchased directly from a bank, and this comes into play if you need your money prior to the maturity of the CD.
If the CD was purchased through a broker-dealer, the CD will likely be “put out for bid” in the market. The bidding process works kind of like a silent auction. Bidders will offer a specific dollar amount for your CD, and you may receive less than the CD’s face value (also called par value), your principal purchase amount. If interest rates have declined since you purchased your CD, you may receive more than your face value. In either case, you will receive the full amount of interest that you earned up until the date of the sale. Again, the broker-dealer may charge transaction fees or other fees on the sale.
If you purchased your CD directly from a bank, the bank would buy it back at face value, but you may incur an early withdrawal penalty, which can be substantial. In either case, you will likely be penalized if you need your money before the maturity of the CD, so try to match the maturity with the point in time you need the money.
If you are somewhat unsure of the date you will need the money, you might consider a CD ladder. Just as a ladder has several rungs, a CD ladder has several maturities. You might put part of the money meant for your wedding, whose date is set a year from now, in a CD that matures in one year, part in a CD that matures in six months, part in a CD that matures in two months, and the rest in a money market account. As wedding expenses arise—the bridal gown, venue, flowers, cake, etc.—the money is safe, is earning interest, and will be available when you need it.
How Do I Know My Savings Are Safe?
Most saving institutions offer some type of insurance protection for your money in case the store becomes insolvent. Think of insurance protection as a money-back guarantee (up to a maximum dollar amount). The amount of insurance protection is related to the type of institution, and it is also related to the owner.
Banks and Thrifts
The Federal Deposit Insurance Corporation (FDIC) insures deposits at commercial banks and thrift institutions. Insurance is offered according to the ownership category and how the accounts is titled. The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category.[i] If you are a single person and have a checking account, a savings account, and a certificate of deposit at your favorite bank with a combined value of $300,000, only $250,000 will be covered by insurance. All of it would be covered by FDIC insurance if you moved $50,000 to a different bank or thrift institution.
Credit unions are covered by a different type of insurance – National Credit Union Share Insurance Fund (NCUSIF). The coverage is like that of the FDIC, and coverage limits are the same.
Brokerage firms are covered by a federal insurance program, the Securities Investor Protection Corporation (SIPC). SIPC coverage provides up to $500,000 in total coverage (up to $250,000 of that for cash) per customer for lost or missing assets, cash and/or securities, from a customer’s accounts held at the institution. It also protects in case of unauthorized trading or theft from the brokerage account. SIPC’s coverage is based on ownership capacities, which are similar to ownership categories. Note that SIPC insurance does not protect an investor from losses due to downward movement in markets.
Before you place your money intended for short-term goals into a savings account, it is important to fully understand the associated costs, fees, or penalties. If the information is not readily available, ask. Then, take advantage of correct ownership titling to safeguard your money and assure full insurance coverage. If you have a very large amount of money for short-term goals, over the limit of insurance coverage, it is a good idea to spread your funds among multiple banks, credit unions, or thrift institutions. Doing this will make sure you have full insurance coverage in the event of an insolvency of one of them. You want your money to be safe!
Bev Bowers, CFP®
Legal Notice: This document is intended to be informational only. Beverly Bowers does not render legal, accounting, or tax advice. Please consult the appropriate legal, accounting, or tax advisor if you require such advice. The opinions expressed in this report are subject to change without notice. The information in this report is from sources believed to be reliable but are not guaranteed to be accurate or complete. All publication rights reserved. Use of this material is subject to the Copyright restrictions described on BevBowers.com.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark and the CERTIFIED FINANCIAL PLANNER™ certification mark in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.