Last week I answered a reader’s question on the difference between an IRA and a 401k and was thrilled to find it well-received. Because of that, I’ll continue answering reader’s questions until you or I get bored with them! The next question comes from Bethany:
Have you ever heard of the ING direct orange account? It’s a savings account that has better returns than just sticking it in the bank. What it is good for? What situations it might be best for and what are the drawbacks?
I’ll combine Bethany’s question with an emergency fund discussion because you should keep your emergency fund in a liquid account which is generally a savings account. I use my savings account for two primary purposes – to hold my emergency fund and for short-term savings, which I consider anything less than five years.
1. Savings account for an emergency fund
One of the staples of getting and staying debt free is to have an emergency fund. While you’re paying off debt, you should have a minimum $1,000 emergency fund so you don’t have to pay for unexpected expenses with a credit card. After you pay off your consumer debt (everything except a mortgage and maybe student loans), you should shoot for 3-6 months of expenses in your emergency fund.
The reason for this large of an emergency fund is to allow you flexibility. If you lose your job or want to quit your job, you’ll be ok for a while if you have the 3-6 month’s worth of expenses in savings. In fact, I found that work came into perspective when I finally paid off my debt and no longer felt like I was working just to pay my lenders. However, that’s a discussion for another day!
2. Savings account for short-term savings
As mentioned earlier, I use a savings account for purchases that will occur within the next five years. This could include a new(er) car, a vacation, or braces for the kiddo. You typically won’t want to invest this money in the stock market because if the market has a big drop like it’s been doing a lot of the last decade, you might not have much time to recuperate the losses before you need the money.
How to find a short-term savings account
Short-term savings accounts include MMA’s (money market accounts), CDs (certificates of deposits), interest bearing checking accounts, and of course the regular savings account through a bank. I’ll cover each one in the priority of what I prefer to use. The most important thing to do when looking for a savings account is to make sure it’s FDIC ensured. This basically means your deposits are insured if your bank goes bankrupt.
High Yield Savings Accounts
High yield savings account are somewhat of a joke because they used to yield 5%+ , but now it’s hard to find anything much over one percent. Just for perspective, if you have $10,000 in a 5% account for a year, you’d receive $500 in interest, but with one percent you’ll only get $100 per year. You can thank the Fed’s loose monetary policy for that!
That being said, we use a high-yield savings account for our short-term savings and emergency fund. We currently use Dollar Savings Direct, but their rates have decreased quite a bit lately, and I’ll probably move to a new bank soon. I use Bankrate.com to find the highest yielding rates, you can use this query for a quick search.
Bethany asked about the ING Orange Savings account which is currently at .75%. It’s a good enough product, but you can find other safe banks with higher returns. At this time, I’d go with Ally which is highly rated and offers .95%.
Interest Bearing Checking Accounts
You can find some pretty good interest rates on these checking accounts, but there are also minimum requirements with them. We don’t use one at this point just because of the minimum requirements. Usually the requirements consist of direct deposit of at least one check, a minimum of 10-12 debit card transaction per month, and a few other things.
Check out CheckingFinder.com to find the best interest bearing checking accounts in your area. Some accounts pay up to 3-5% interest so it can definitely be worth it.
CD’s (Certificate of Deposit)
CD’s are basically savings accounts with minimum time requirements. You can find CD’s with about any timeframe, but they are typically between a few months and 5+ years. The longer term CD’s usually offer a higher interest rates, but it’s still hard to find anything over 2%.
We don’t use CD’s because of the minimum time requirements. The penalties aren’t too onerous and usually will take back a few month’s worth of interest if you remove the money before the regular time period.
MMA’s (Money Market Accounts)
MMA’s are my least favorite because it’s possible for your investment to lose value because of how the MMA is invested. This never really happened until 2007 when all of the banks were collapsing and some of the MMA’s went down with it. I say no thanks to MMA’s.
It stinks to get such a small return from your money, and on paper you might be losing a little money because inflation rates are higher than interest rates. However, the purpose of short-term savings is to have the money around when you need it. When interest rates start going back up, you’ll once again get rewarded more handsomely for your savings. Until then, just be proud of yourself for having money in these accounts!