Where to Save

By: AARP Education & Outreach | Source: AARP.org | April 17, 2006

You have lots of choices of where to save your money. If you know the differences among the various choices you can make the best choice of what you need.

Common savings vehicles include:

• Savings accounts
• Money market accounts
• Money market funds
• Certificates of Deposit (CDs)

The most important factors in choosing the place to save are:

• Access. How quickly can you access your money?
• Safety. How safe is your money?
• Earnings. How much money will you earn?

Savings Accounts

Savings accounts are the simplest vehicles for protecting your savings. Banks make loans with your savings money, then share with you the interest they earn. You will generally earn small amounts of interest, but you will have instant access to your money. This ready access means your money is "liquid."

Many people open a savings account where they have a checking account. Not only is this convenient, but it can also lower your fees. For instance, if you link the two accounts, you can use the savings money as emergency overdraft protection, in case you accidentally spend more than you have in your checking account. Having a savings account where you bank also makes it easy to make deposits. They can be made automatically with each paycheck deposited in your checking account, or you can visit a local ATM or branch. If you bank online you can transfer money between your accounts from the convenience of your home computer.

Savings accounts are very safe. Accounts at banks are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per individual account. Savings at credit unions are insured up to $250,000 per individual account by a private company that handles insurance for credit unions.

Certificates of Deposit (CD)

A certificate of deposit, or CD, is a special type of deposit account that typically offers a higher rate of interest than regular savings accounts or money market accounts. In exchange for receiving higher interest, however, you tie up your money for a set length of time, generally one month to five years. If you withdraw your money early, you pay a penalty. Therefore, you sacrifice quick access in favor of earning more interest.
 
The most common place to buy a CD is at the bank or credit union, but you can also get them at brokerage firms. Brokers buy their CDs through a bank and then resell them to you. They might negotiate a higher rate of interest for a CD by promising to bring a certain number of deposits to a particular banking institution. However, there may also be a higher fee. CDs are safe investments. The Federal Deposit Insurance Corporation insures CDs up to $250,000 per account.

Here are other factors to consider:
Early withdrawal penalty. Most banks charge you an early-withdrawal fee. That's why CDs are appropriate only when you are fairly sure you won't need the money before the due date. 

FDIC insured? Make sure the FDIC insures the bank that issues your CD. This will protect your CD account from losses up to $250,000. If you're buying a CD through a brokerage firm, make sure the bank that issued the CD to the broker has FDIC insurance. Otherwise, you will have insurance through SIPC, the private insurer of the securities industry.

Is there a "call" feature? Some CDs have a clause that allows the bank to terminate the agreement before the maturity date. The name for this is a "call" feature. If this happens, you'll be repaid in full but you won't earn the interest that would have been paid to you for the remainder of the term. This may be a disadvantage—you may have to reinvest this money unexpectedly in something with a lower rate—so ask if there's a call feature before you invest.

Get it in writing. Make sure you receive a written document that tells you the length of time your money will be tied up, the interest rate, and whether you will be paid monthly or twice a year.

CD Ladders: A Strategy for Protection

Some people "ladder" their CDs. This is a strategy where you split up your savings and buy CDs with different due dates. CD ladders help you get higher yields while still giving you some access to your cash. It works like this:  The longer you agree to tie up your money in a CD, the higher the interest you will receive. So, you might buy a one-month CD, a three-month CD, a one-year CD, and three-year CD. If you put all your money in the three-year CD, you would earn higher interest overall. But by laddering, you can buy new CDs with some of your money sooner; and if interest rates go up during that time, you can buy new CDs at even higher rates instead of being locked into CDs with lower rates. Explore whether setting up a CD ladder makes sense for you.

Money Market Accounts

Money market accounts are similar to savings accounts. For the consumer, the biggest difference is that money market accounts tend to pay higher interest than savings accounts. They are covered by the same insurance as savings accounts, depending on whether you're at a bank or a credit union. You may even be able to link the money market account to your checking account, just as you might do with a savings account.

When you open a money market account, you're agreeing to let your financial institution make very short-term loans (often overnight) in the "money market." Big companies and other institutions often borrow large amounts of money for brief times in order to cover an immediate need for cash.

Money Market Funds

Money market mutual funds are similar to money market accounts, but they are not the same thing. Money market funds try to maintain a consisten share price of $1 by paying out all of the earnings to shareholders and by avoiding securities that can rise and fall in price (so there are no capital gains to distribute). How do they differ?

• A money market fund is a mutual fund; a money market account is a savings vehicle at your bank.
• Although they are considered safe, money market funds are not insured by the FDIC. Under a new temporary government guarantee program, companies can purchase coverage for money maket fund account balances as of September 19, 2008.
• You may not be able to get your money immediately (unless the firm arranges for access to ATM machines).
• Money market funds may pay higher interest than you would get with a money market account.

AARP's Money Matters Tip Sheet on Where to Park Your Savings has more information and action steps.