Courtesy of Elizabeth Aldrich
Elizabeth Aldrich.
It took me a long time to finally get into the habit of saving my money on a regular basis. Once I finally did, the question then became: Where do I park my savings?
Bank accounts are about as one-size-fits-all as shoes, and that's especially the case for savings accounts. Different accounts are geared toward different savings goals.
My first savings goal was to build up an emergency fund. After that, I wanted to focus on building a retirement fund while also saving for other goals, which included everything from a 30th birthday vacation to graduate school to possibly buying land one day. For each of these goals, I needed to consider a different type of account.
Generally speaking, choosing where to park your money involves negotiating between liquidity and returns. The most liquid options, such as a checking account, offer the lowest returns. On the other hand, investments that aren't very liquid at all, such as property and retirement accounts, offer some of the highest returns. The sooner you think you'll need your money, the more liquid you want it to be.
After saving up $20,000 for an emergency fund, this is the savings strategy I came up with - and it's earning me hundreds of dollars per year while keeping my money relatively liquid.
I split my savings between a high-yield savings account and a certificate of deposit
While I figured I could get by with a $10,000 emergency fund, I decided to double my savings goal and aim for $20,000. I wanted to have a $10,000 emergency fund to cover, well, emergencies, but I also wanted a $10,000 "f*ck off fund" to cover my next adventure - whether that's starting a business, going to graduate school, or moving to a different country.
I saved up the $20,000 by setting up weekly automatic deposits into my high-yield savings account with Ally Bank. Once I achieved my goal, I decided it was time to open a different account for half of my savings, since the two funds serve different purposes.
My emergency fund is money I could need at the drop of a hat, so I wanted it to be liquid. I left that $10,000 in my high-yield savings account because I can access that money within a few days, and I'm still earning 20 times the national average for savings accounts.
However, my f*ck off fund didn't need to be quite as liquid. This money is intended to be used for a major life decision, and I want to take my time with that decision rather than making it impulsively. When I saw that Ally Bank was offering a special rate on its 12-Month High-Yield CD, I opened an account and transferred the other $10,000 to my new certificate of deposit (CD).
What is a certificate of deposit (CD), and how does it work?
There are various types of CDs but the basic premise is that you're offered a slightly higher interest rate for locking your funds up for a certain period of time.
For example, my 12-month CD came with a 2.35% APY, higher than the 1.90% APY currently offered by Ally's high-yield savings account. However, unlike a high-yield savings account, I can't simply withdraw my money whenever I want. I have to wait 12 months to access my money, or I'll be charged a penalty for withdrawing it early.
The penalties for early withdrawal on CD accounts are usually significant. For my 12-month CD with Ally Bank, the penalty for early withdrawal is 60 days of interest. This means that by taking my money out before my 12 months are complete, I'd probably end up earning less with the CD than I would've if I'd just left my money in a high-yield savings account.
The pros and cons of opening a CD
I really like my Ally Bank CD. I could've gotten a slightly higher interest rate at a few other places, but I already had my money in an account with Ally Bank, and it has excellent customer service. Their CD is easy to open and fund online, and it has a $0 minimum deposit requirement.
The main drawback of putting your money into a CD is, of course, that you don't have quick access to that money. While you can still take your money out if an emergency occurs, you'll have to pay a penalty. That's why CDs are best for money you know you won't need for a while.
On the other hand, if you're saving money for long-term goals and don't expect to touch it for another 10 years, you could get far better returns by investing your money in other ways rather than relying on a CD. Both high-yield savings accounts and CDs offer more generous interest rates than traditional savings accounts, but they still barely keep up with the inflation rate.
That being said, splitting up my emergency fund and short-term savings between a high-yield savings account and a 12-month CD is working well for me. If I'd kept all $20,000 in a traditional savings account, I would've only earned a few dollars in interest by the end of one year. If I put it all in Ally's high-yield savings account, I'd earn roughly $380 in interest in one year, which well worth the minutes it takes to open an account online.
By putting $10,000 in a high-yield savings account and $10,000 in a 12-month CD, however, I stand to earn $428 in a year. It's not a huge difference, but it's basically free money, so why not?
Personal Finance Insider offers tools and calculators to help you make smart decisions with your money. We do not give investment advice or encourage you to buy or sell stocks or other financial products. What you decide to do with your money is up to you. If you take action based on one of the recommendations listed in the calculator, we get a small share of the revenue from our commerce partners.
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