Understanding Savings Accounts: Their Purpose and Functionality
In today’s world, managing multiple financial responsibilities makes saving money more important than ever. Savings accounts are bank accounts that earn interest, though there may be some restrictions on how often and how you can withdraw money. While they won’t make you rich, savings accounts are a useful tool for achieving financial goals.
**What Is a Savings Account?**
A savings account is a place to store money for future needs, like an emergency fund or a down payment. Unlike a checking account, which is meant for frequent transactions, a savings account is designed to help you save money and earn interest on your balance.
**How Does a Savings Account Work?**
When you deposit money into a savings account, the bank uses it to lend to others and charges them interest. In return, the bank pays you interest on your deposits. In the rare case that the bank fails, your money is insured up to $250,000 by the Federal Deposit Insurance Corp. or the National Credit Union Administration in the United States.
**Why Do You Need a Savings Account?**
Even if you think you don’t have enough money to save, it’s important to start somewhere. Many banks don’t require a minimum deposit, so even small amounts can help you begin to benefit from having a savings account.
**Motivation To Save**
A savings account encourages you to save money. For example, if you have an extra $100 in your checking account each month, you might be tempted to spend it. But if you transfer that money to your savings account, you’ll have $1,200 by the end of the year, plus any interest earned.
**Build an Emergency Fund**
Set an initial goal to build an emergency fund once you open your savings account. Experts recommend having three to six months’ worth of living expenses saved to cover unexpected financial emergencies. However, many people fall short of this goal. A survey by GOBankingRates found that 39% of women and 33% of men have $100 or less in their savings accounts.
**Avoid Debt**
Saving for large purchases instead of using credit helps you build financial discipline and avoid debt. Even if you pay off your credit cards each month, using them can lead to more frequent spending. Research by MIT Sloan professor Drazen Prelec shows that people are willing to pay up to twice as much for an item when using a credit card compared to cash.
**How a Savings Account Can Help You Grow Your Money**
A savings account not only stores your money but also helps it grow through interest. The interest earned is compounded, meaning you earn interest on both your deposits and the interest already earned. For example, if you deposit $1,000 at 4% interest compounded daily, you would earn $40.81 in the first year, $42.47 in the second year, and $44.21 in the third year. This is more than simple interest, which would give you a flat $40 per year.
The power of compound interest lies in its ability to grow your savings faster over time. By developing a habit of saving, you can see significant growth in your savings account.