Issue 12  •  Spring 2013

Save Yourself First

Written by Andrea Davila
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Dying to go backpacking with your best friend around Romania? Want to learn how to fly an airplane? Committed to opening an animal shelter? While learning about and maintaining your financial health might seem much more lame than any of the above, it is one of the most important tools you have to help create the life you dream of living, and do all the things you dream of doing. Money for Nothing aims to demystify that scary and confusing world of personal finance for all us normal folks out there.
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Illustration by Melissa Fasolino
 
Dying to go backpacking with your best friend around Romania? Want to learn how to fly an {mosimage width=450 height=400} airplane? Committed to opening an animal shelter? While learning about and maintaining your financial health might seem much more lame than any of the above, it is one of the most important tools you have to help create the life you dream of living, and do all the things you dream of doing. Money for Nothing aims to demystify that scary and confusing world of personal finance for all us normal folks out there.

This episode of Money for Nothing is all about savings and savings accounts. While, in recent years, “saving money” has almost seemed like a dirty expression since no one was doing it—not even adults (see my last Money for Nothing article)—it is now the new fad. Household savings rates have climbed out from negatives in the past two years and are now hovering around 3-4 percent. And not soon enough!

First off, if you think you don’t have enough money to qualify for this discussion, you’re wrong. You either have some excess cash in your checking account (more on that further down), or some excess room in your budget for savings (more on that in a later column).

More importantly, EVERYONE should be saving some of their money, no matter how much or how little they make. Why? Think about it: where’s the first place your money goes? If you’re like me, you’re probably primarily paying bills and buying food, and then hopefully getting some goodies (clothes, books, music) if there is any leftover money. But, if you lose your job, will your landlord pay your rent? Will AT&T pick up your phone bill? Who will financially provide for you if you’re not working? Your savings.

While we’re busy paying all these other people, we often forget to pay ourselves to hedge against future downturns. Paying yourself, aka saving money, is the cornerstone of any successful financial life.

Now that we’re all going to be saving machines, how to proceed? I’ll lay out the various strategies you can employ in saving money, how to determine how much (and where) to save, and most important, EXACTLY how to do it. There’ll be lots of information, so be warned, you might want to get out a pen and paper.

High-Yield Savings Accounts

Right now, you've probably got a checking account at a regular bank that is linked to a standard savings account. Mostly likely, your savings account is earning around 1 percent interest and that checking account is earning probably around 0 percent. You can check these numbers by calling your bank. (For a more detailed explanation of what interest is, see the last Money for Nothing article) Currently, the inflation rate is negative, but usually it is around 2-3 percent. Why does the inflation rate matter?
 
The short story is that if you're currently earning less in your bank accounts (the 0-1 percent in your accounts) than the rate of inflation (the 2-3 percent), you're actually losing money; that is, over time your money will buy you less goods. That might sound confusing, but that’s the way inflation works. We can discuss it further another time, or you can just trust me on this one.

A good way to counter this effect would be to open up a savings account with a higher interest rate than the rate of inflation, and ideally with the highest interest rate you can find. This probably means going to an online bank and opening up a high-yield savings account, which is a regular FDIC* insured savings account with a higher interest rate than average, due to the fact that the bank (being online) has lower overhead costs, and can therefore pay you more interest. Here is a current list of high-yield savings accounts and their respective interest rates. It takes about ten minutes to open an account, provided you have your checkbook and current bank statement. For full disclosure, I have both an ING Direct Orange account and a SmartyPig account. Neither have any minimum balances or fees.

Certificates of Deposit (CDs)
The name of the game in finance is risk versus reward, and personal finance is no different. A high-yield savings account is extremely safe, and it is also extremely liquid, which means you can access the cash in the account really easily, usually within a day or two. However, if you’re willing to take a little bit more risk with your money, you might consider a certificate of deposit, or, as it is commonly known, a CD.

CDs are also insured by the FDIC, so you are never at risk of losing the cash you put into the account (FYI, this is called your “principle,” in finance terms), but you DO have to take another risk: timing. A CD requires you to sign on to a period of time (usually called the “term” of the CD) over which you cannot access your money. In exchange for this risk, you will usually get a little bit higher of an interest rate than in a savings account, and that rate will not fluctuate in the future.

For example, you can put your money in a three-month CD with a 4 percent interest rate. This means, if you put $100 into the account, at the end of the three months you’ll have $104. But this also means that if any time DURING the three months you need that $100, you’re totally SOL.

You have some recourse, but in order to extract that money you’ll have to pay a heavy penalty, which will wind up making the investment not really worthwhile in the first place. Moral of this story: CDs are even better than the high-yield savings accounts, but only if you’re willing to lock away your money for a specific period of time. CD terms usually run in three-month intervals (and they start when you deposit your money in the CD), so three month, six month, and one year CDs are pretty common.

Money Market Accounts

The best account of both worlds is a money market account. The interest rates are generally higher than in high-yield savings accounts, and you don’t have to lock your money away like you do in a CD. The catch? (IMPORTANT LIFE LESSON: There is always a catch. Be on the lookout for it.) The minimum balances are much higher—usually in the five to ten thousand dollar range, while for a CD or high-yield savings account, you might not even need to meet a minimum balance. So unless you’re rolling in the dough, this might not be an option for you.

Just Do It

First of all, determine how much money you can put into a savings account. If you have any money in your checking account left over after all your monthly expenses, you probably have a bit of wiggle room to move some over to savings. Next, determine your liquidity needs. Do you often have emergencies where you need to dip into your savings (and I don't mean that really expensive and delicious triple cream Brie you saw at Whole Foods!)? If so, a CD might not be the right vehicle for you.

Once you know how much money you’re putting in an account, and what account to put your money into, you are ready. You can even set up direct deposit from your checking to your savings every month and totally forget about that savings account. It is a beautiful thing to forget about; when you remember and check, the balance will be so much higher, and you’ll feel so, so good. I promise.

*The FDIC stands for the Federal Depository Insurance Corporation, which is a fancy name for insurance in case your bank fails. Any amount up to two hundred and fifty thousand dollars per depositor at a single bank is backed by the full faith and credit of the US government. All this mumbo jumbo basically means that you needn’t worry about your money if it is FDIC insured!

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