Post by Zoinkers on Mar 1, 2007 5:38:44 GMT -5
Different types of savings vehicles allow you to access your money and earn interest too. See which is best for you.
Saving is the first step in a financial plan, and there are several ways you can save money, earn more money with that money through interest and still have access to it should you need it. In this chapter, you'll learn how much money you can earn through annual and compound interest and how interest rates are set. Then we'll look at the differences between savings accounts, money market accounts and money market funds.
Develop a savings plan
By Bankrate.com
The difference between rate and yield is determined by how frequently interest is paid and how it is paid.
Rate is the nominal, or stated, interest rate on the investment. If you have a CD with a 5-percent nominal rate or APR, interest is calculated by multiplying the amount invested by 5 percent and by the fraction of a year the money is invested.
Let's say interest is paid annually. A $10,000 investment will earn $500 in interest. ($10,000 x 5 percent x one year.) When an investment pays interest annually, its rate and its yield are the same.
But when interest is paid more frequently, the yield goes up. That's because the interest payment is credited to the CD more quickly and it starts earning interest along with the invested principal.
Annual interest
A $10,000 investment will earn $500 in interest. When an investment pays interest annually, its rate and its yield are the same at 5%.
$10,000 x 5% x one year
Compound interest
If the 5 percent CD paid interest twice a year, the six-month interest payment would be $250.
$10,000 x 5% x 0.5 years
Then the $250 payment starts earning interest, too, and earns $6.25 in interest during the next six months.
$250 x 5% x 0.5 years
If the 5 percent CD paid interest twice a year, the six-month interest payment would be $250, ($10,000 x 5 percent x 0.5 years.) Then the $250 payment starts earning interest, too, and earns $6.25 in interest during the next six months, ($250 x 5 percent x 0.5 years.) That extra interest is added on and starts earning more interest. That's what compounding interest is all about.
The first CD, where interest was paid just once during the year, earned $500 in interest after a year, but the second CD, where interest was paid twice during the year, earned $506.25 in interest. The rate and yield on the first CD is 5 percent. The rate on the second CD is 5 percent, but its yield is 5.06 percent.
To get that yield you must reinvest the interest.
How interest rates are determined
By Bankrate.com
You need to know how to calculate the interest you'll get by leaving your money on deposit for a certain amount of time, but it's also good to know how financial institutions arrive at the interest rates they advertise.
Interest rates are affected by a number of factors. The Federal Reserve, which is charged with maintaining the stability of the nation's financial system, raises or lowers short-term interest rates in an effort to maintain that stability. The Fed regularly takes these actions in response to economic ups and downs that the country goes through on a fairly routine basis.
Regular interest rate adjustments
Short-term rates are raised in what are called expansions -- good times -- to keep the economy from building too fast and risking inflation. Inflation is when too much money chases too few goods and services, sending prices upward. Raising interest rates slows down the economy because it makes it more expensive for you and for businesses to borrow money, which means you'll have less to spend.
The Fed will lower short-term rates when the economy is contracting -- slowing down. Lowering rates makes it less expensive to borrow money. Now you and businesses can afford to buy more products and services. That speeds up the economy and keeps it from sinking into a recession. A recession happens when consumers hold on to their money or don't have much and don't buy the products and services that keep companies afloat and employees employed.
When the Fed cuts short-term rates it is cutting the rate that banks charge each other to borrow money. Those cuts are eventually passed on to businesses and consumers. The same thing happens in reverse when the Fed raises short-term rates.
Other factors and their impacts
Other factors affect interest rates, too, but on a more irregular basis. A crisis involving the foreign oil-producing nations, for example, could have a major economic impact that could affect interest rates.
Long-term interest rates aren't affected as quickly by economic conditions as are short-term rates, but there is a trickle-down factor and they reflect the impact eventually.
What works for you as a saver works against you as a borrower. When rates are high, you're earning a hefty amount of interest for your deposits, but you're going to pay a high interest rate if you need to borrow.
When rates fall, you don't get much interest on your savings, but it's a lot cheaper to borrow money.
Savings accounts
By Bankrate.com
The most basic way to save money is in a savings account at your bank. Savings accounts come in two flavors, passbook and statement. You don't usually get to pick; most banks carry one or the other.
Passbook vs. statement savings account
With a passbook account you're given a booklet to enter deposits, withdrawals and interest. With a statement savings account you simply receive a statement, usually once a month, detailing transactions. These "deposit" accounts are insured up to $100,000 by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Share Insurance Fund (NCUSIF) at a credit union.
At a glance
Savings accounts are liquid, meaning you can get your money out at any time. Federal regulations limit you to six electronic, telephone or preauthorized transfers per month and no more than three of them can be by check, draft or debit card. But, generally, you can make unlimited withdrawals by teller or ATM. There's always a caveat -- some banks allow only three free withdrawals per month unless you carry a high balance, i.e. $2500 or more. Be sure you understand the bank's policies before opening an account.
The minimum balance required to open a savings account is usually quite low, sometimes just $1 or $5, but don't let that fool you. Many institutions require a minimum balance of $100, $300 or more to avoid paying a monthly maintenance fee. Those fees can be stiff, $5 or even $10 a month, and will erode your money quickly.
The interest earned on a savings account is where you can make a big difference to the bottom line. Most traditional banks pay very little interest on savings accounts, a quarter of a percent is common. You can do much better by using one of the high-yield savings or money market accounts that, typically, are found online. High-yield money market accounts allow you to write checks, while high-yield savings accounts don't have that feature. However, some high-yield savings accounts let you link to your checking account to make deposits and withdrawals easier.
Opening an account online is easy but it may not be the way to go for everyone. Some people aren't comfortable putting confidential information online, some want a local branch that they can walk into and talk with someone face-to-face if there's a problem with their account. But it may be worth getting past some of the qualms if you have, or plan to build, a significant savings account.
• Savings accounts are liquid
• Limited preauthorized transfers
• Unlimited withdrawals (note possible associated fees)
• Minimum balance required (note possible monthly maintenance fees)
• Savings accounts earn interest (higher interest options: high yield and money market accounts)
• Online and face-to-face account options
• Emergency fund
A savings account can be a great place to build and keep your emergency fund. Everyone should have enough cash on hand to see them through three to six months of unemployment. An emergency fund can also be used to see you through a true emergency: Getting your only car running again is an emergency, replacing a broken television is not.
Money market accounts
By Bankrate.com
When it comes to investing, most would-be Warren Buffets sparkle at the thought of hot stocks that double overnight and penny stocks that turn into bundles of bucks. But here at Bankrate.com, we start with the first rule of careful investing: Don't lose money.
At a glance
That means two things in investing: Save on fees and commissions by making wise choices in how and where you put your money, and getting the best return you possibly can while avoiding as much risk as possible.
When it comes to low-risk investing, that means fixed income. It means bonds and certificates of deposit, money market accounts and mutual funds, annuities and savings accounts. It means finding a bank where you can park your money without paying for the privilege, and getting a little interest while you're at it. It means properly setting up your CD portfolio and deciding which type of bond is best for you.
Money market account
• MMAs are liquid
• Check writing and money transfer privileges (often have minimum requirements, limitations and fees) MMAs are available at most banks or credit unions
• Deposits may be insured up to $100,000 by the FDIC for non-retirement accounts
• Minimum balance required, may be higher than a savings account requires
• MMAs will earn about twice the interest of a savings account
• Some online banks institutions ofter high-yield MMAs which offer better rates higher risk
High yields MMAs
With a visit to our Investing Basics, you can learn about the different types of fixed income investments, and the advantages and disadvantages of each. You can learn how to find the best savings account for your needs and about the different types of bonds. You can learn about fixed-income alternatives you might not have thought about.
After all, you worked hard for your money. Now you can learn how to make your money work hard for you.
Money market funds
By Bankrate.com
Banks, brokerages and mutual fund companies offer money market mutual funds (MMF). They're most commonly used by people with brokerage accounts who sell a stock and then put the proceeds in a MMF until they decide where to reinvest the cash. But these funds can be used to build cash for an emergency fund or other short-term goals.
At a glance
Money market funds are not FDIC insured, even if you open an account at a bank, but if you're willing to take just the slightest bit of risk with your liquid savings, check them out because they pay a better rate than a basic bank money market account (MMA.)
The reason it's OK to take on the risk is because MMFs are highly regulated and invest in very safe, short-term debt securities such as certificates of deposits and U.S. Treasury bills. The funds try to maintain a share price of $1. There's no guarantee a fund will be able to maintain the share price, but no consumer has ever lost money in one of these funds.
Money market funds
• MMFs are not FDIC insured
• Higher rates than MMAs
• Check writing and money transfer privileges (often have minimum requirements, limitations and fees)
• Withdrawals may have fees
• Limited pre-authorized short-term debt securities
• Safe, secure and regulated short-term debt securities
• Fees (expense ratio) are included to cover fund management
• Taxable and tax-free funds
High yield MMAs
Since someone is paid to oversee the fund and manage the investments in it, you'll pay a fee called the expense ratio, which helps pay the cost of running the fund. The advertised yield has already had the expense ratio deducted. Fees reduce the yield so it's always important to look for a fund with a low expense ratio. Vanguard has a reputation for having some of the lowest fees around. If they're charging an expense ratio of .30 percent, it's fair to assume that the industry average is perhaps .50 percent. You'd want to avoid funds charging much above that. You can find the expense ratio information in the prospectus and on many brokerage or stock Web sites.
Money market funds are divided into two categories, taxable and tax-free. Taxable funds usually pay a higher yield, but that doesn't always make them a better deal. If you're weighing a taxable fund against a tax-free fund, you'll need to do some math called the tax-equivalent yield formula to see which will give you the better return.
Money market funds allow you to write checks and make electronic transfers, but most accounts establish a minimum dollar amount. Electronic, telephone and pre-authorized transactions are limited by federal regulations to six per month, with no more than three being by check, draft or debit card. Check with your institution to see if it imposes a fee after a certain number of withdrawals if your account balance drops below a certain level.
Saving is the first step in a financial plan, and there are several ways you can save money, earn more money with that money through interest and still have access to it should you need it. In this chapter, you'll learn how much money you can earn through annual and compound interest and how interest rates are set. Then we'll look at the differences between savings accounts, money market accounts and money market funds.
Develop a savings plan
By Bankrate.com
The difference between rate and yield is determined by how frequently interest is paid and how it is paid.
Rate is the nominal, or stated, interest rate on the investment. If you have a CD with a 5-percent nominal rate or APR, interest is calculated by multiplying the amount invested by 5 percent and by the fraction of a year the money is invested.
Let's say interest is paid annually. A $10,000 investment will earn $500 in interest. ($10,000 x 5 percent x one year.) When an investment pays interest annually, its rate and its yield are the same.
But when interest is paid more frequently, the yield goes up. That's because the interest payment is credited to the CD more quickly and it starts earning interest along with the invested principal.
Annual interest
A $10,000 investment will earn $500 in interest. When an investment pays interest annually, its rate and its yield are the same at 5%.
$10,000 x 5% x one year
Compound interest
If the 5 percent CD paid interest twice a year, the six-month interest payment would be $250.
$10,000 x 5% x 0.5 years
Then the $250 payment starts earning interest, too, and earns $6.25 in interest during the next six months.
$250 x 5% x 0.5 years
If the 5 percent CD paid interest twice a year, the six-month interest payment would be $250, ($10,000 x 5 percent x 0.5 years.) Then the $250 payment starts earning interest, too, and earns $6.25 in interest during the next six months, ($250 x 5 percent x 0.5 years.) That extra interest is added on and starts earning more interest. That's what compounding interest is all about.
The first CD, where interest was paid just once during the year, earned $500 in interest after a year, but the second CD, where interest was paid twice during the year, earned $506.25 in interest. The rate and yield on the first CD is 5 percent. The rate on the second CD is 5 percent, but its yield is 5.06 percent.
To get that yield you must reinvest the interest.
How interest rates are determined
By Bankrate.com
You need to know how to calculate the interest you'll get by leaving your money on deposit for a certain amount of time, but it's also good to know how financial institutions arrive at the interest rates they advertise.
Interest rates are affected by a number of factors. The Federal Reserve, which is charged with maintaining the stability of the nation's financial system, raises or lowers short-term interest rates in an effort to maintain that stability. The Fed regularly takes these actions in response to economic ups and downs that the country goes through on a fairly routine basis.
Regular interest rate adjustments
Short-term rates are raised in what are called expansions -- good times -- to keep the economy from building too fast and risking inflation. Inflation is when too much money chases too few goods and services, sending prices upward. Raising interest rates slows down the economy because it makes it more expensive for you and for businesses to borrow money, which means you'll have less to spend.
The Fed will lower short-term rates when the economy is contracting -- slowing down. Lowering rates makes it less expensive to borrow money. Now you and businesses can afford to buy more products and services. That speeds up the economy and keeps it from sinking into a recession. A recession happens when consumers hold on to their money or don't have much and don't buy the products and services that keep companies afloat and employees employed.
When the Fed cuts short-term rates it is cutting the rate that banks charge each other to borrow money. Those cuts are eventually passed on to businesses and consumers. The same thing happens in reverse when the Fed raises short-term rates.
Other factors and their impacts
Other factors affect interest rates, too, but on a more irregular basis. A crisis involving the foreign oil-producing nations, for example, could have a major economic impact that could affect interest rates.
Long-term interest rates aren't affected as quickly by economic conditions as are short-term rates, but there is a trickle-down factor and they reflect the impact eventually.
What works for you as a saver works against you as a borrower. When rates are high, you're earning a hefty amount of interest for your deposits, but you're going to pay a high interest rate if you need to borrow.
When rates fall, you don't get much interest on your savings, but it's a lot cheaper to borrow money.
Savings accounts
By Bankrate.com
The most basic way to save money is in a savings account at your bank. Savings accounts come in two flavors, passbook and statement. You don't usually get to pick; most banks carry one or the other.
Passbook vs. statement savings account
With a passbook account you're given a booklet to enter deposits, withdrawals and interest. With a statement savings account you simply receive a statement, usually once a month, detailing transactions. These "deposit" accounts are insured up to $100,000 by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Share Insurance Fund (NCUSIF) at a credit union.
At a glance
Savings accounts are liquid, meaning you can get your money out at any time. Federal regulations limit you to six electronic, telephone or preauthorized transfers per month and no more than three of them can be by check, draft or debit card. But, generally, you can make unlimited withdrawals by teller or ATM. There's always a caveat -- some banks allow only three free withdrawals per month unless you carry a high balance, i.e. $2500 or more. Be sure you understand the bank's policies before opening an account.
The minimum balance required to open a savings account is usually quite low, sometimes just $1 or $5, but don't let that fool you. Many institutions require a minimum balance of $100, $300 or more to avoid paying a monthly maintenance fee. Those fees can be stiff, $5 or even $10 a month, and will erode your money quickly.
The interest earned on a savings account is where you can make a big difference to the bottom line. Most traditional banks pay very little interest on savings accounts, a quarter of a percent is common. You can do much better by using one of the high-yield savings or money market accounts that, typically, are found online. High-yield money market accounts allow you to write checks, while high-yield savings accounts don't have that feature. However, some high-yield savings accounts let you link to your checking account to make deposits and withdrawals easier.
Opening an account online is easy but it may not be the way to go for everyone. Some people aren't comfortable putting confidential information online, some want a local branch that they can walk into and talk with someone face-to-face if there's a problem with their account. But it may be worth getting past some of the qualms if you have, or plan to build, a significant savings account.
• Savings accounts are liquid
• Limited preauthorized transfers
• Unlimited withdrawals (note possible associated fees)
• Minimum balance required (note possible monthly maintenance fees)
• Savings accounts earn interest (higher interest options: high yield and money market accounts)
• Online and face-to-face account options
• Emergency fund
A savings account can be a great place to build and keep your emergency fund. Everyone should have enough cash on hand to see them through three to six months of unemployment. An emergency fund can also be used to see you through a true emergency: Getting your only car running again is an emergency, replacing a broken television is not.
Money market accounts
By Bankrate.com
When it comes to investing, most would-be Warren Buffets sparkle at the thought of hot stocks that double overnight and penny stocks that turn into bundles of bucks. But here at Bankrate.com, we start with the first rule of careful investing: Don't lose money.
At a glance
That means two things in investing: Save on fees and commissions by making wise choices in how and where you put your money, and getting the best return you possibly can while avoiding as much risk as possible.
When it comes to low-risk investing, that means fixed income. It means bonds and certificates of deposit, money market accounts and mutual funds, annuities and savings accounts. It means finding a bank where you can park your money without paying for the privilege, and getting a little interest while you're at it. It means properly setting up your CD portfolio and deciding which type of bond is best for you.
Money market account
• MMAs are liquid
• Check writing and money transfer privileges (often have minimum requirements, limitations and fees) MMAs are available at most banks or credit unions
• Deposits may be insured up to $100,000 by the FDIC for non-retirement accounts
• Minimum balance required, may be higher than a savings account requires
• MMAs will earn about twice the interest of a savings account
• Some online banks institutions ofter high-yield MMAs which offer better rates higher risk
High yields MMAs
With a visit to our Investing Basics, you can learn about the different types of fixed income investments, and the advantages and disadvantages of each. You can learn how to find the best savings account for your needs and about the different types of bonds. You can learn about fixed-income alternatives you might not have thought about.
After all, you worked hard for your money. Now you can learn how to make your money work hard for you.
Money market funds
By Bankrate.com
Banks, brokerages and mutual fund companies offer money market mutual funds (MMF). They're most commonly used by people with brokerage accounts who sell a stock and then put the proceeds in a MMF until they decide where to reinvest the cash. But these funds can be used to build cash for an emergency fund or other short-term goals.
At a glance
Money market funds are not FDIC insured, even if you open an account at a bank, but if you're willing to take just the slightest bit of risk with your liquid savings, check them out because they pay a better rate than a basic bank money market account (MMA.)
The reason it's OK to take on the risk is because MMFs are highly regulated and invest in very safe, short-term debt securities such as certificates of deposits and U.S. Treasury bills. The funds try to maintain a share price of $1. There's no guarantee a fund will be able to maintain the share price, but no consumer has ever lost money in one of these funds.
Money market funds
• MMFs are not FDIC insured
• Higher rates than MMAs
• Check writing and money transfer privileges (often have minimum requirements, limitations and fees)
• Withdrawals may have fees
• Limited pre-authorized short-term debt securities
• Safe, secure and regulated short-term debt securities
• Fees (expense ratio) are included to cover fund management
• Taxable and tax-free funds
High yield MMAs
Since someone is paid to oversee the fund and manage the investments in it, you'll pay a fee called the expense ratio, which helps pay the cost of running the fund. The advertised yield has already had the expense ratio deducted. Fees reduce the yield so it's always important to look for a fund with a low expense ratio. Vanguard has a reputation for having some of the lowest fees around. If they're charging an expense ratio of .30 percent, it's fair to assume that the industry average is perhaps .50 percent. You'd want to avoid funds charging much above that. You can find the expense ratio information in the prospectus and on many brokerage or stock Web sites.
Money market funds are divided into two categories, taxable and tax-free. Taxable funds usually pay a higher yield, but that doesn't always make them a better deal. If you're weighing a taxable fund against a tax-free fund, you'll need to do some math called the tax-equivalent yield formula to see which will give you the better return.
Money market funds allow you to write checks and make electronic transfers, but most accounts establish a minimum dollar amount. Electronic, telephone and pre-authorized transactions are limited by federal regulations to six per month, with no more than three being by check, draft or debit card. Check with your institution to see if it imposes a fee after a certain number of withdrawals if your account balance drops below a certain level.