Checking vs Savings Accounts: Do You Need Both?
Checkings and savings accounts are the pillars of personal finance. Learn the advantages and disadvantages of each type of account, and why you should have both.
In the world of personal finance, we have many relationships with banks and financial service providers. Credit cards, deposit accounts, car insurance, investment accounts, car loans, and educational debit - all individual accounts which are linked to us through a financial institution. But no accounts are more popular or fundamental than Savings and Checking accounts.
What is a Savings Account?
A Savings Account is a financial account, held at a bank in your name, separate from your checking account which allows you to store funds and hopefully receive interest. Covered under the FDIC these accounts normally have a small minimum balance requirement to open an account but do not charge a monthly maintenance fee of any sort. Savings accounts are easier to set up than ever with the popularity of online banking and you can now open an account with a large financial institution or even a small credit union from the comfort of your own home.
Upside: Having a savings account allows you to divide your accessible funds into different groups and hopefully save cash for things like emergencies or big expenses in the future without the difficulties associated with investing in stocks or bonds which can be harder to sell quickly for needed cash. Additionally, most good savings accounts will provide you with some interest in the deposits held. The funds provided as a return on your funds is called the interest rate and can change over time based on the market. At present, the average interest on a savings account is 0.09% APY(1) however some savings accounts can offer as high as 2% annually. This is a meaningful improvement from the 0.0% offered on standard checking accounts in the US.
Downside: The main downside to the savings account is in what’s called “liquidity”. Liquidity is the ability to move funds freely from place to place. If you have millions of dollars but all of that value is tied up in real estate, you would be considered “illiquid”. Banks want to keep as many deposits under their roof as possible to support their lending business, and, to incentivize people to keep their cash at a bank, small amounts of interest are offered to have customers keep their money in a savings account, instead of a checking account. The price that users have to pay to receive the interest on the funds held in their savings account is a slight reduction in liquidity. Federal laws restrict the number of times that you can make transfers out of a savings account to six(6) per month (although if you make those withdrawals at the actual bank via ATM or teller that restriction does not apply). More than six withdrawals in a month and you will likely incur a fee with your bank or may have a transfer fail.
What is a Checking Account?
Checking accounts are the most common financial accounts among consumers. Unlike most savings accounts, a checking account may have a debit card associated with it to allow you to make purchases at merchants while allowing you to make unlimited deposits and withdrawals within a given month. If you keep a minimum balance (these vary but are commonly around $100 average daily balance) normally there are no monthly fees associated with a checking account, especially if you link the account to your direct deposit from your employer.
Upside: The money held in a checking account is the most liquid of any bank account you have, short of that already in your pocket. Accessible via bank branch, ATM withdrawals or through debit card transactions, the funds held in your checking account can be spent anywhere and anytime.
Downside: A lack of interest is the main downside associated with checking accounts. Although most American’s keep more money in their checking accounts than ever ($2T at last check), on average banks offer no interest for checking account deposits(2). Additionally, because you can write checks and use a debit card associated with your checking account there is an opportunity for you to spend more money than then you have (overdraw your account). Although avoidable with smart alerts and careful monitoring of your balances, overdrawing your account will likely result in overdraft fees from your bank which might be charged daily until the overdraft is cleared.
Do I need both a Checking and a Savings account?
It sure doesn’t hurt. Individuals should have several different accounts to handle different aspects of their finances and having a savings and a checking account is a great start. In practice, you should only keep the funds in your checking account that you will need in the immediate term (to pay for things like bills, etc.) Funds beyond immediate needs should be spread between your savings account (emergency funds) and longer-term investments like stocks and bonds held in an investment account. Another reason that it is a good idea to have a separate savings account is that partitioning your money can make it feel like it might be harder to spend.
Imagine the following scenario:
Single Account: You have one checking account where you keep all of your money and you currently have $500. In your head, that $500 is actually $100 of emergency savings and $400 of coverage for bills. You get an email about an amazing sale on hiking gear and you just NEED to buy a new pair of boots because the sale is too good. You look at your account balance and see that you have $500. You know that part of that money is for expenses, but you are pretty sure you will be ok to spend a bit of it, so you go for some $200 boots. The new balance is $300, savings is $0 and you are $100 short on your bills. Not great.
Savings and Checking Accounts: You have both a savings and a checking bank account. You get paid once a month and those funds are deposited into your checking account which you use to pay bills. Part of your salary you transfer over to your savings account so that you have some funds in case of an emergency. Your current balance is $400 in your checking account and then an additional $100 in your savings account. You get an email about an amazing sale on hiking gear. You find a pair of hiking boots that you would love to have but they are $200. You confirm your balances for your checking account where you keep money for bills and note that if you buy the $200 boots you won’t have the funds to cover your expenses. You COULD transfer some money over from your savings account to your checking account to help cover those expenses, but then your savings account would be at $0 which is unsettling. You pass on the boot purchase. Checking account balance stays at $400 and savings continues on at $100.
That small amount of friction created by keeping funds in two different accounts can be a powerful tool to help you keep on top of your personal finances, but it’s not the only reason you should set up several different financial accounts.
The main reason to have so many accounts is that each has an associated amount of risk and a corresponding amount of return. Below is a chart of the annual rates associated with the various types of accounts you might have.
If we look at “annual rate” as either a positive or negative number we can see how important it is to not only know what the rates on our accounts are but to prioritize where your funds are held.
- If you paid all of your bills for the month and found yourself with $100 extra dollars you might be tempted to keep those funds in your checking account. But let’s see what those funds could do over the course of a year:
- If you kept that money in your checking account earning 0% you will be subject to standard inflation which will reduce the buying power of those funds by roughly 2%, leaving you with only $98 from your original $100.
- If you put that $100 in your savings account, you might be able to get as much as 2% from a high yield account which would keep the buying power your funds intact at $100.
- If you paid down $100 of outstanding credit card debt you would save yourself $18 in interest charges (or more).
Knowing the rates on your accounts can save you thousands of dollars over time, and with a bit of planning, you can help to balance savings with debt reduction over time to improve your financial health with each passing day.
At Astra, we develop tools to help people automate the movement of money. Through clever automation, we can take some of the work out of personal finance and establish smart routines that act on your behalf to move money where it should be when it should be. Here is to a better and more secure financial future!
Sources:
(1) https://fred.stlouisfed.org/series/SAVNRNJ
(3) https://docs.google.com/spreadsheets/d/1i8hExp8Llf0QoIsDJg9-qKDzaXvZqFq22Gt_DYP3Twc/edit#gid=0