Saving Money the Old-Fashioned Way
We’ve all heard the tag line from the brokerage firm, “We make money the old-fashioned way – we earn it.” That’s a great concept and one some of our children need to learn, but that’s not what we’re about this month. This month, we want to look at the old-fashioned way of saving.
It used to be the word “saving” meant we got our paycheck, took it to our bank, credit union or savings and loan, and deposited some of it. In return, we got what was considered an acceptable interest rate – say 5%. But that’s not necessarily the best way of saving these days.
In the first place, the 5% we used to get on a regular savings account is more like 2% to 3% these days. That in itself requires you to think before deciding on a savings vehicle.
Second, many bank accounts have service fees that can more than eat up the interest earnings on small balances. Again, that requires the small saver to shop for the best deal before settling on a savings account.
Make no mistake about it, shopping is what you will have to do if you want to find the best place to put your money. While it is comforting to have all your funds at a local bank you can trust, sometimes the bank’s service fees can be beat by another, equally good, bank.
First, lets take a look at savings and how much you should have. The general rule of thumb is that you should have savings of approximately six months of after-tax income in liquid investments (i.e. cash, money market accounts, checking and savings accounts). This is on top of whatever you may be putting away for retirement.
Why would you want to save and where would you put your money. Well, it depends. If you are saving for a particular purpose – say to purchase next year’s Christmas presents – a regular savings account or a Christmas club account may suit your needs. One of the attractions of regular bank savings accounts is they are readily accessible to the saver and it is generally pretty easy to set up an automatic withdrawal from your checking account to your savings account.
Unfortunately, you pay for the ease with which you can access your money. Most savings accounts have a service fee if the balance in the account goes below a set amount. Additionally, typical interest rates for regular bank savings accounts are only 2% to 3%. This makes the average savings account good mainly for parking your cash until you can move it to a more profitable account, if you intend to keep your money for any period of time (6 months to five years) and you don’t need ready access to your cash.
In cases where you are saving for big-ticket items or just building your cash reserves, you may want to look at a money market account. Most, if not all, banks offer money market accounts and there are numerous money market mutual funds. These funds are ideal for parking your money for a longer period of time, but having ready access to them in an emergency at attractive rates.
In contrast to savings accounts, the average 7-day yield on the best funds was 6.22% and the average for all non-government money market funds was 5.5% as of January 23, 2001. These funds generally don’t charge service fees, although you can be sure the money managers do get paid for their efforts. This is generally accomplished by charging expenses prior to determining the yield to the investor.
You may ask why not just put your money in these accounts to begin with? Unfortunately, many of these funds have minimum initial balances of anywhere from $1,000 to over $25,000. Many savers simply cannot afford this buy-in. While the funds in these accounts are generally accessible by check, many times funds place limits on the number of transactions in a month. On the flip side, if you want to make a withdrawal, you may be required to withdraw more than you wish because of minimum check amounts. Therefore, the accessibility of the funds is not as easy as a savings account. Still these are excellent vehicles for those who are able to meet the requirements for entry and want or need reasonable access to the funds.
If you are looking for the best possible interest rate and do not mind tying your money up for an extended period of time, you always have the option of investing in a certificate of deposit. A certificate of deposit is basically a savings vehicle that ties your money up for a specified period of time. It can be anywhere from 1 month to ten years. In exchange, you get a better interest rate than you would on other types of bank accounts. For example, a typical one year certificate of deposit can range anywhere from 6% to 6.5%.
You may compare this to the money market accounts previously mentioned and decide the money market accounts are better. However, remember the minimum buy-in to these funds can be steep and did we mention the FDIC does not insure them? We don’t mean to imply that the good money market funds are unstable. On the contrary, they are very stable. However, there is some comfort in the knowledge your savings is insured up to $100,000 by the Federal Government.
You may also wish to invest in U.S. Savings bonds, but these are generally better suited to long-term investments such as college savings.
Whatever method you choose to start your savings plan, the bottom line is you need to start it. Probably the most effective way to begin your plan is to ask your employer to withhold the amount you wish to save and put the money into your savings account directly. If your employer pays by direct deposit, this should not be a significant burden to them.
If your employer does not do this, your next line of defense is your bank or the money market fund. Most banks and money market funds are more than happy to automatically draft your account. That is, they are more than willing to take the money from your checking account and put it into your savings account or money market fund.
If all else fails, treat your savings plan as if it were any other bill. Set it up to be paid just like you would your electricity bill and then make the check out each month. This requires a great deal of discipline, but the rewards are tremendous.
This month we have touched on something that may seem elementary, but it is key. The sooner you begin your savings plan, the sooner you can build up a nest egg to protect you in down times. It will also allow you to accumulate the funds necessary to move to the next level of investing for the long-term. A strong savings plan will give you peace of mind and help you meet your financial goals. Give us a call and let us help you decide where you need to start. You know you will be glad you did.