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- One of the best ways to save money is to earn interest on the money you’ve already saved. But you can’t do that in a regular checking account.
- There are infinite options and places to keep your money, but three obvious choices to start earning interest on your savings are high-yield savings accounts, certificates of deposit, and mutual funds.
- Generally, you can earn more money by investing your money in the stock market through mutual funds, but that’s also the highest-risk option.
Saving money is hard.
Data shows that Americans – particularly younger generations – are struggling to save even $US400. More than half have less than $US1,000 in savings, and many of us are drastically under-saving for our retirement goals.
The tragic irony is that one of the best ways to save money is to earn interest on money you already have saved, thanks to compound interest. The sooner you save, the easier it will be to save more.
There are infinite options out there, but you don’t have to consider every possibility right off the bat. If you just want to take a step forward and help your money start earning some more money, here are a few smart options, from least risk to most risk.
Option 1: Store money in a savings account
Most people are familiar with this option and might have had a savings account bundled in with their checking account at the bank. A savings account is similar to a checking account, except there is slightly higher interest, and a federally imposed six-withdrawal-per-month limit.
There is a great variety of interest rates offered with savings accounts, with low-end accounts earning as little as 0.15% and higher-end accounts topping out at just over 2%. There can also be monthly fees and minimum required balances – but not at every bank, so finding the right account makes a big difference.
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While having a savings account associated with your checking-account bank certainly is convenient, it’s not always the most lucrative option. The past 10 years have seen the emergence of online high-yield savings accounts.
These companies, such as Ally Bank and Synchrony, tend to offer industry high rates of over 2% by cutting the cost of in-person bankers. Many have stellar reviews, and if you’re comfortable transacting online, they could be worth pursuing.
Option 2: Store money in a certificate of deposit (CD)
Before we continue further it’s important to take note of the inverse relationship between liquidity and interest earned. The longer you are willing to let an institution hold your money without touching it, the more interest they tend to give you. This is the fundamental trade-off with most savings instruments.
A certificate of deposit is an instrument that gives you a fixed interest rate and maturity date, before which you cannot access your money (without penalty). There are a range of maturity dates – typically from three months to five years – and the interest rates associated with each follow the rule above. The longer the maturity date or withdrawal date, the higher the interest earned.
The good news about CDs is they tend to be fairly uniform in their offerings across banks. Looking at Barclays, Synchrony, and Marcus by Goldman Sachs, all offer virtually identical rates for 1-year, 3-year, and 5-year CDs. A CD will be slightly more competitive than a savings account, with an interest rate of 2% to 3%, depending on the maturity period.
CDs are very low-risk and insured by the Federal Deposit Insurance Corp. (FDIC). The main question you want to ask yourself when deciding between a CD and savings account is, “Am I 100% certain I won’t want to access this money during the maturation period?” If you do, there will be a penalty that will likely offset any extra interest earned.
Option 3: Invest money in a mutual fund
With CDs, we outlined the relationship between interest rate and liquidity. Another equally important relationship is that between interest earned and risk level. The riskier an asset, the higher the yield has to be to make it a competitive product. Savings accounts and CDs are considered to have virtually no risk because they are federally insured up to $US250,000 and, as a result, have fixed, low interest rates.
A mutual fund, on the other hand, is not federally insured and has the potential to either grow in high multiples or result in a loss. That is because a mutual fund is not a bank but rather a group of investors who pool their money into a communal fund, which is then invested into assets such as stocks and bonds. Mutual funds have money managers and boards, who tend to make decisions about how to invest the fund’s money.
By pooling resources and hiring money managers, mutual funds are able to mitigate a lot of the risk associated with individually investing in securities while still maintaining a relatively high yield for their shareholders. The intention of a mutual fund – including its desired rate of return, risk profile, and share liquidity – differ from one to the next.
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Mutual funds have both annual operating fees, typically 1% to 3%, and shareholder fees, which are a percentage paid out when one sells their shares of the fund.
Giving an average rate of return on a mutual fund is tricky, as the performance differs so much based on the market. If you were to take a mutual fund during a bull-market year, you could easily see returns of 12% to 15%. Take that same fund over a bear year, and you could see returns as low as 3%.
Instead of trying to compare your desired mutual fund with an average, you should instead look at its performance relative to others of the same class. Barring catastrophic market conditions (note: We’ve seen a few in our lifetime), a mutual fund will yield quite a bit more than a CD, with even the low-end funds usually realising returns of more than 4.5%.
When it comes to saving your money, the two important factors are risk tolerance and liquidity. If you have lots of cash in a checking account earning 0.01%, it’s in your best interest, to well, earn interest on it. Whether a savings account, certificate of deposit, or mutual fund seems most appealing to you, as long as you understand the use case for each, and the associated benefit, you’re likely to put your money to good use.
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