Building a savings account is in many ways comparable to body building. Once you start, you need to stick with your workout regimen or you might as well not start. Also, much like bodybuilding, you need to have a variety of exercises that build different parts of your anatomy – you would look pretty strange walking around with bulging arms and skinny legs.
The three most important factors in building savings are setting a goal and sticking to it, keeping your commitment to savings, and deciding which method or methods to use. “You really have to know yourself and discipline yourself if you’re going to be an effective saver,” says Greg McBride, CFA, Bankrate’s chief financial analyst, on Bankrate.com.
Once you decide what your savings goal is, there are three primary ways to save without risk of losing your money. Keep in mind, however, the lower the risk, the lower the interest you earn annually (also referred to as annual percentage yield, or APY) and vice versa.
A Basic Savings Account
Let’s start with the most basic way and that is the standard passbook savings account. While this is probably a good place to start, especially if you are younger and not making a lot of money, it should be that – a start.
Even the largest financial institutions offer very low interest rates (or “yield”) on passbook savings. For instance, a credit union we know will pay you 0.05 percent if you maintain at least $100 in your savings account. Although a low rate, keep in mind that most savings accounts earn compound interest, that is, you earn interest on the interest that you have earned.
So, if you open your account with $500 and religiously deposit $250 monthly into that account, at the end of 10 years you will, with compound interest, have saved $30,577. At end of 15 years, $45,672, and at the end of 20 years, $60,805. This is according to our calculation on handsonbanking.org.
What other ways are there to save with little or no risk and perhaps a better yield? If you’re looking for no or low risk savings, then your choices are a money market account or a certificate of deposit, both of which are kissing cousins to a standard savings account.
A Money Market Account
According to NerdWallet.com, a money market account is in fact a type of savings account with the same protections and generally a higher interest rate because it also requires that you maintain a higher minimum balance in your account than would most savings accounts. Money market accounts are backed by the Federal Deposit Insurance Corporation at banks and the National Credit Union Administration at credit unions for up to $250,000 per depositor.
The same credit union previously cited offers a money market account that earns 0.15 percent if you maintain a minimum balance of $2,500 in your account. If you contribute $500 monthly, at the end of 10 years you will have saved $62,987, and after 20 years, $124,388, per handsonbanking.org.
A Certificate of Deposit
What about a certificate of deposit, or CD? Now you are moving out of the savings account world and into a more sophisticated investment realm, although not the stock or bond markets. NerdWallet.com explains that a CD is primarily different from a traditional savings account in that it is a so-called “timed deposit.”
With a savings and money market account, you can deposit and withdraw funds relatively freely, which is termed “liquidity.” However, a CD requires you to invest a certain amount of money, such as $5,000, for a specific amount of time or term length. Term lengths can be as short as a few days or as long as a decade, but the standard range of options is between three months and five years.
Let’s say you want to invest $5,000 and after some online research you find a financial institution that will pay you 1.95 percent interest. After five years, that investment will grow to $5,507 without adding any more funds and without any more effort on your part. Not a bad way to earn money.
For a risk-adverse saver, a combination of CDs coupled with market money and passbook savings accounts might be your best bet if you want to earn some interest income but sleep soundly.
One final thought about savings. Many financial managers will advise that if you’re serious about building your savings muscle over the long term for, let’s say, retirement, you should also consider investing in higher risk instruments such as stocks and bonds, or perhaps real estate, that can generate higher financial returns.
“Putting money into savings is important, but to make sure that money grows or even just maintains its worth over the years with inflation, you need to have an investment strategy,” writes Jessica Moorhouse of the blog Mo’ Money Mo’ Houses on the Intuit Mint website. “The more you save, you need to make sure that a big chunk of change is put to good use, and that might mean putting it into bonds, stocks, or other investments.”
If you go this route, however, it’s important to find a balance between taking too much risk and not enough, which requires specific knowledge, experience and expertise. To this end, you may want to retain a financial adviser recommended by someone you know and trust.