It would seem that the decision to put your money into an interest bearing account would be a no-brainer, but often times a no-interest checking account will be more cost effective. Having said that, how do you decide what interest bearing accounts to put your hard earned money into? One issue with interest-bearing accounts is the minimum balance that often must be maintained in order to avoid fees. The higher the balance required, the higher the likelihood that your fees will be waived.
The problem that can come up is that often the expense of maintaining the account exceeds the amount of interest that you earn on the account. Often times you have to take into account the cost of tying up your cash in a low-yielding account. To put it in plain terms, let’s say that you end up paying $4 a month in account fees, plus you have to pay ATM fees. If you earn 2% interest on that account, you would have to keep at least $2400 in your account to break even for the year.
Even if you don’t pay fees on your accounts you will still have to work hard to earn any money on the accounts. This is simply because the interest rates that you typically earn on checking and savings accounts do not outpace the national rate of inflation. The rate of inflation currently has been resting at just over 3% annually. This means that basically you end up losing purchasing power. What that means is that you are losing money.
Now that we have established the fact that low-yielding accounts lose money there are other ways to get better returns out of your money with a bank. Two of the most common ways to do this are through CDs (certificates of deposit), or through money market accounts. These are the two most common accounts that have higher interest and also two of the safest ways to get more out of your money.
Considering CDs
Instead of parking the majority of your money in a checking or savings account, consider a CD. If you already have one of these accounts at your bank the next step would be to consider whether or not your CD can be linked to your other accounts so that you can have an easier time meeting minimum balance requirements.
When you open a CD you agree to not withdraw your money for a period of time; this period usually runs anywhere from 3 months to 5 years or more. The shorter the term of the CD, the lower the rate you will get because of the shorter amount of time your money is locked up.
One specific advantage that these accounts do have is if interest rates fall, you are locked into the rate you were quoted when you bought the CD. However on the flip side, if the rate rises you are stuck with the lower rate. You do have access to the money prior to the term of your CD expiring, but you will pay penalties. Typically you will have to pay 3 months interest for early withdrawal.
Another important thing to remember if you have a large sum of money locked up in a CD is this: While most banks or credit unions have jumbo CD options for amounts over $100,000; anything over $250,000 is not insured. So the excess is only as secure as the institution. Also important to remember is that at the end of 2013 the amount the FDIC will insure per account will fall back to $100,000.
It is important to also check the rate itself. You want to check if it is fixed rate or variable. You also want to know how the interest is compounded. Whether it is daily, weekly, monthly, quarterly, or yearly; this will affect the amount of money that your CD earns. You will also want to let the institution know if you want the CD to roll over when the term is up, or if you want it deposited in one of your deposit accounts.
Money Market Options
Many banks or credit unions offer money market deposit accounts. These accounts typically invest loans into government agencies or corporations. Typically they require somewhere around $2500 on deposit. Because the minimum is high, often times a money market account is fee free.
Often times you will be able to write free checks against your account. However, there may be a minimum check-writing amount and you are probably going to be limited on how many you can write in a month.
Also keep in mind with money market accounts that many banks offer tiered money market rates. This works precisely how it sounds. The more money you put in your money market the higher the interest rate you will earn. These interest rates often do not outpace inflation as well.
Again, as with CD’s, it is important to consider how your interest is compounded – if it is daily, weekly or monthly.
An important resource for money market accounts is credit unions. They typically have lower balances to open and maintain money market accounts and have significantly lower fees if you fail to maintain that balance. For example, with NC State Employees Credit Union where I bank it requires $250 minimum balance to open, and also to avoid fees. However if you fall below $250 you will only be charged a $2 fee. So check to see if you are eligible for any credit union memberships.
Shopping for accounts
When shopping for interest-bearing accounts, always consider the yields and how they are reviewed. Yields are updated regularly, often times on a weekly basis. This may cause rates to raise and lower quickly. That means that the rate that was offered when you opened your account may be dramatically lower a year, or even a month later. Keep in mind that banks can quote these rates daily, weekly, monthly, quarterly or even yearly.
Over a period of 12 months, interest that compounds yearly could yield much less per month than when a lower interest rate compounds daily. To accurately determine how to compare these accounts you need to ask for each accounts “annual percentage yield,” in addition to its interest rate. Most institutions quote interest rates and APYs, but only the APY is calculated the same way by all.
As with most banking related decisions, do your homework and you’ll be assured the best experience and the biggest bang for your buck.
Stay tuned for our next post on online banking.
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