In this economy, it seems harder than ever to make your money work for you.
Is a money market account the way to go, or is a long-term CD worthwhile? Should I open a basic savings account instead of an IRA?
We work hard for our money. It shouldn’t be a lot of work to figure out how to make it grow.
Paying off debt and establishing a savings plan takes discipline, but no one would disagree that it’s a worthwhile effort. With so many people unstable in their jobs or unemployed, food and gas at record high prices, and homeowners losing equity, building a financial cushion has become a necessity.
For those who are unemployed or forced to live paycheck-to-paycheck, building a savings may not be top of mind right now. But if you have even a little discretionary income, or hope to in the future, it’s important to know your options.
Figure out your goals
Before choosing where to dump your money, it’s best it figure out what you are allocating it for. Do you need an account to save for living expenses in the case of a job loss, or will the money be used for next year’s big anniversary trip? Or perhaps you’re saving for something even further down the road.
The length of time you will be saving helps determine where your extra money should go.
Also think about how liquid this account needs to be. Will you be “borrowing” here and there, or is this cash “out of sight, out of mind” until absolutely necessary? Are there other penalty-free accounts you can draw from in case of an emergency?
In most cases, it’s probably best to consider multiple accounts, since there likely will be more than one goal you are looking to achieve. Don’t be afraid to spread your money too thin. A dollar here and a dollar there still adds up to $2, even if the interest made is not quite as high.
Look at your alternatives
After earmarking your savings amounts, figuring out the liquidity needed, and deciding how many accounts are required, it’s time to get educated on what your options are.
Considering you are not a Wall Street heavyweight, your best bet is to look at what your local banks have to offer in the way of savings accounts CDs, (certificates of deposit), money market accounts, and IRAs (individual retirement accounts).
Here is a brief lowdown on what each type has to offer in terms of savings.
- Saving accounts – If you are not put off by lower interest rates and need total liquidity to withdraw your money at any time, savings accounts are for you. It’s a good idea to have at least one account like this for emergency money, if for nothing else.
- CDs – With CDs, you will get higher interest rates in exchange for less liquidity. If you’re looking to build your money, it’s best to reinvest the interest, rather than spend it. CDs with longer maturities or time periods will pay a higher interest rate, but you will pay a penalty for an early withdrawal. Be sure to shop around for the highest interest rates.
- Money market accounts – A money market is a type of deposit account, like checking and savings, that typically offers higher interest rates. This is because account holders will have less access due to limited transactions permitted each month. This is a good choice for those who tend to withdraw money more often than they should.
- IRA – The two most often used IRAs are traditional and Roth IRAs. With both, you are limited in the amount you can contribute. With traditional IRAs, these contributions are deductible, so you end up paying less taxes. Asset growth in this account is also tax deferred. With a Roth IRA, you fund it with after-tax dollars and future withdrawals are tax free. This means contributions will be taxed once and earnings will never be taxed. By law, you cannot withdraw money from an IRA until you are 59.5 years old. Early withdrawals are typically subject to a 10% penalty and taxation equal at your current rate.
Note that rates, requirements, and investment options vary, both by account type and by financial institution. Thus, it may literally pay to do your homework when searching for the best savings option.