on where to put your money
July 23, 2010, 7:20 pm
Filed under: advice, financial | Tags: , , , , , ,

Dear Ask Spoonah

I recently sold my car to cut back on expenses and am looking to put the money from the sale to work. I heard that online banks have higher interest rates for savings and money market accounts, but I wonder are they better than a brick and mortar bank in the long run? Also is there a big difference between a money market account, savings account, or certificate of deposit?

~Savings Newbie

dear savings newbie,

first, congratulations on having the courage to make such a big move to support your financial goals! that’s a tough choice.

to answer your first question, there are a number of differences between traditional brick & mortar banks and online banks. obviously there is the issue of convenience and time, in that traditional banks allow easy access to our money just as soon as we can get there, where online banks are accessed online only and can often take up to several days to transfer funds to an account you can “get at”. this can be a good thing if you are trying to use the online account for savings (as it keeps you from making impulse withdrawals). the other main benefit, which you brought up, is online banking often offers higher rates on interest bearing accounts such as savings and money market accounts, and often offer interest on traditionally no-interest accounts (such as checking accounts). so to answer your question, the benefits to using an online bank for savings accounts are higher interest rates, so it can definitely be a good decision in the long run, especially if you plan to deposit large enough sums of money or for long enough periods of time that the difference in interest rates will make up for the lack of convenient access to the funds. I use online banking for my emergency savings accounts myself, as well as when I’m saving for other things and want to “hide” the money from myself so that I can’t take it out for impulses.

as for the differences between savings, money market accounts, and certificates of deposit (CDs), there are again a few benefits and drawbacks to each. the differences are primarily in terms of interest rates and liquidity (ease of access). savings accounts are the most liquid but generally offer the lowest interest rates. these are great for things such as short-term savings (of a year or less) or when you think you might need the funds within a few days (i.e. emergency savings). CDs are purchased for a set period of time before maturation, and the longer the time (from a few weeks to several years), the higher the interest you will gain. CDs promise a fixed interest rate determined at the time of purchase. they are a safe investment with a rate you can be sure of, but they lack access to the funds before the maturation date. money market accounts, on the other hand (not to be confused with money market funds, which are not FDIC insured and are riskier), are more liquid (like checking or savings accounts), and offer a competitive interest rate (which may vary). these often have a high minimum balance and limit the number of times in a month you may withdraw from them.

to summarize:

in order of liquidity, high to low—savings, money markets, CDs
in order of interest rates, high to low—CDs, money markets, savings

if you’re sure you won’t need the money for a specified amount of time (like a year or more), then I say put it in a CD. otherwise, shop around for the best going rates on a savings or money market account. all three of these options are FDIC insured.

happy saving!