The banking profession is almost as old as civilization itself. In their simplest form, banks took the money of a large number of people and lent that money to borrowers. When borrowers paid back their debts to the bank, they would have to pay some extra. The banks would then convey a portion of this extra money earned to the original people from whom the banks received money. While the [|]banking industry[:|] has become much more complex than this in modern times, the basic principal of receiving deposits and paying people for the deposits they make continues in the form of savings accounts. Customers can deposit their cash into banks in this way for safekeeping and to earn money from the bank.
Interest From Savings Accounts
When one party owes money to another party over a certain period of time, a fee is usually assessed. This is called interest. Just as banks charge interest for the loans they make, they also pay interest to people who deposit money into savings accounts. The amount of money you will make by depositing your money in this way is usually expressed as an interest rate.
For instance, if your savings account comes with a 1 percent interest rate, this means that your bank will pay you 1 percent of the total amount you have deposited into your account for every year that the money remains in the account. Unfortunately, compared to nearly every other type of investment instrument, a savings account usually yields the lowest interest rates available. This is due in part to the fact that a savings account comes with virtually zero risk to the cash deposited.
One important matter to bear in mind when calculating what you will gain in interest for your savings is the matter of compounding. If you deposit $1,000 in a savings account at 1 percent interest and never withdraw anything from that account for the next 10 years, you will not just receive $10 every year in interest. Rather, the total amount of interest you receive will increase year by year because of interest on your interest (1 percent of $1,010 for the second year, and so on). This is called compound interest.
Depending on the specific type of savings account you have or the bank you use, there may be a monthly or annual fee involved with having a savings account. Banks charge these fees to keep from losing money by servicing a high volume of accounts with low balances. Most banks that charge such fees allow clients to get those fees waived by meeting certain requirements, such as having a recurring [|]direct deposit[:|] or maintaining a [|]minimum account balance[:|]. The specifics vary from bank to bank.
The Internal Revenue Service does not tax you for having money in a savings account. However, the interest that you earn on that account is taxable income. This interest income is taxed on a different scale from hourly wages, though: it is taxed as capital gains. As a taxpayer, you must report your interest earnings annually.
Interest Versus Inflation
One of the most disheartening things to be said about savings accounts is that keeping your money in one may actually result in a loss of wealth. Even if you avoid paying fees and receive interest payments from your bank, as long as the interest rate is lower than the inflation rate, the real value of the money in your account is consistently decreasing, even if the nominal value continues to grow. For instance, in the United States, it may be difficult to find a savings account that pays more than 1 percent interest, but inflation rates tend to hover around 2 percent or 3 percent.
For many who seek to put their money away, the low yields that savings accounts offer are simply unacceptable. For this reason, they look for alternatives. One of the basic rules of investment is that risk and potential return are directly related. [|]High-risk investment instruments[:|] tend to come with a high payoff, while low-risk investment instruments tend to have a low payoff.
As mentioned previously, savings accounts are virtually risk-free, which is why they earn depositors so little. In some cases, though, those seeking to put money away can enjoy a substantially higher yield for only a very small increase of risk. For instance, government bonds are generally viewed as low-risk or no-risk investments, and their interest rates often track inflation rates quite closely. Another alternative may be a long-term Certificate of Deposit, as these come with low rates of interest and usually offer higher yield rates (see: CD Rates). Bear in mind, though, that CDs also usually come with early withdrawal penalties.
Online Versus Brick-And-Mortar
If you are intent on getting a savings account, consider the difference between an [|]online savings account[:|] and a savings account through a more traditional, brick-and-mortar bank. While traditional banks can be more convenient and offer a wider array of services and products, the fact that they offer so much makes it difficult for them to provide competitive rates. Some online banks specialize in industry-beating savings accounts with yield rates that traditional banks cannot match. In opening your savings account, look around and see what various banks have to offer before you make your decision.