At a typical bank, you can open 2 different kinds of accounts that have different purposes: savings and checking. Savings accounts are for precisely that: saving money. Checking accounts, on the other hand, are for income and expenses. You’ll get a card, called a debit card, which, when you use it at a store, will take money directly from your checking account to make the purchase, so you won’t have to pay for it later like you would with a credit card. It is expected that there will be lots of transactions through an account like this: Ed’s paycheck came in, then he paid his rent, bought groceries every week, filled up his car every 5 days, went to the doctor, took his girlfriend on a date to a restaurant and then to see a movie, and so on.
But savings accounts are to build a cushion: in case Ed’s car breaks down and he needs to buy a new one, if Ed wants to have enough for a down payment so he can buy rather than have to rent, and so on. So, banks want to disincentivize transferring out of savings as if it were a checking account, and they usually do this by attaching a fee of a few dollars per transaction, over a certain number of transactions going out, per month.
Banks also need to incentivize you to keep your money with them, as opposed to following the cliché, and stuffing your money under a mattress. They do this by paying you interest.
Both checking and savings accounts give you interest. This time, interest is good, because it’s the bank paying you to keep your money with them, rather than the bank charging you the cost of giving you a loan. But the rates at which these accounts provide you with interest are wildly different. Let's take a look:
But savings accounts are to build a cushion: in case Ed’s car breaks down and he needs to buy a new one, if Ed wants to have enough for a down payment so he can buy rather than have to rent, and so on. So, banks want to disincentivize transferring out of savings as if it were a checking account, and they usually do this by attaching a fee of a few dollars per transaction, over a certain number of transactions going out, per month.
Banks also need to incentivize you to keep your money with them, as opposed to following the cliché, and stuffing your money under a mattress. They do this by paying you interest.
Both checking and savings accounts give you interest. This time, interest is good, because it’s the bank paying you to keep your money with them, rather than the bank charging you the cost of giving you a loan. But the rates at which these accounts provide you with interest are wildly different. Let's take a look:
Interest on a checking account can be tiny, sometimes 0.01% -- $1 in interest per $10,000, paid out as about 8 cents per month. So, after 10 years, assuming Fred parked your $10,000 in checking, didn’t spend any of it, and came back at the end of the period, Fred would see his balance was now $10,010. Fred didn't add any more money to his account after his initial $10,000 deposit, so we know the extra was all interest. $10,010 minus $10,000 is $10, which is how much he earned in interest over those 10 years: just a dollar a year. But Fred shouldn't worry, because there are other types of accounts that he (and we) should look at which pay much higher returns because these accounts have different purposes.
Fred could put his money into a traditional savings account. There are two basic types of savings accounts: traditional and high-yield. A traditional savings account usually pays somewhere between 1 and 2% interest annually (let’s split the difference at 1.5% for this example). Making the same assumptions about Fred’s $10,000, if Fred had put his money in a regular savings account, and not touched it, he’d end up with about $11,620 after 10 years. That extra $1,620 was the interest he earned. Look at the difference. In 10 years, Fred got paid $10 in interest from his checking account-- that's a dollar a year, on average-- whereas his savings account paid him $1,620 over 10 years, which is $162 a year. I don't know about you, but if I have a chance to earn $1 or $162 a year, I'll definitely take the $162!
Fred, finally, could have chosen to put his money into a high-yield savings account, which we’ll say averages 4.5% interest per year—triple the rate of the traditional savings account. Making the same assumptions about Fred’s $10,000, if Fred had put his money in a high-yield savings account, he’d end up with about $15,670 after 10 years.
Let's end with a similar comparison for the high-yield savings account. Remember, before we do the math: the checking account paid him $1 in interest every year, and the traditional savings account paid him $162 every year. His balancing the high-yield savings account, finally, increased by $5,670 over 10 years, which is, on average, $567 in interest a year: more than triple the average annual payout of the traditional savings account, and hundreds of times as much as the checking account!
Fred could put his money into a traditional savings account. There are two basic types of savings accounts: traditional and high-yield. A traditional savings account usually pays somewhere between 1 and 2% interest annually (let’s split the difference at 1.5% for this example). Making the same assumptions about Fred’s $10,000, if Fred had put his money in a regular savings account, and not touched it, he’d end up with about $11,620 after 10 years. That extra $1,620 was the interest he earned. Look at the difference. In 10 years, Fred got paid $10 in interest from his checking account-- that's a dollar a year, on average-- whereas his savings account paid him $1,620 over 10 years, which is $162 a year. I don't know about you, but if I have a chance to earn $1 or $162 a year, I'll definitely take the $162!
Fred, finally, could have chosen to put his money into a high-yield savings account, which we’ll say averages 4.5% interest per year—triple the rate of the traditional savings account. Making the same assumptions about Fred’s $10,000, if Fred had put his money in a high-yield savings account, he’d end up with about $15,670 after 10 years.
Let's end with a similar comparison for the high-yield savings account. Remember, before we do the math: the checking account paid him $1 in interest every year, and the traditional savings account paid him $162 every year. His balancing the high-yield savings account, finally, increased by $5,670 over 10 years, which is, on average, $567 in interest a year: more than triple the average annual payout of the traditional savings account, and hundreds of times as much as the checking account!
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