3 Types of Bank Account and How to Use Them

Whether you invest in the stock market or not, bank accounts are a vital investment and savings vehicle. No matter how much or little money you have, everyone needs to set aside money that is guaranteed to be there when you need it. Savings in a bank are not considered a “sexy” investment choice and you will not become rich with your money stashed there. However, we all need the protection they offer should something happen and you need cash immediately.

The first thing you need to do is make sure your bank has a web-based portal for you to fully manage your account. This is where you take almost all of your banking actions. Below, I will discuss the three types of accounts that I recommend as well as the strategy you may use to invest your money.

Checking Account

The checking account is the most elementary of bank accounts. It will offer a very low interest rate (if at all) and the main purpose of your checking account is to use it as a “lobby”. This is where your income comes in and where all expenses go out.

Have your paycheck deposited to this account. You may pay all of your expenses from this account (i.e., writing checks, paying bills, withdrawing cash, etc.). If any money remains (hopefully there is at least some), transfer those funds to a linked savings account.

Linked accounts are two or more separate accounts that are linked together because those accounts have the same owner at the same financial institution (bank). You create a link between accounts to view all of your accounts together and easily transfer money between them.

*Note: Make sure to always keep enough money in your checking account to cover one month’s worth of bills plus a few hundred dollars. The extra few hundred dollars will prevent overdraft fees and/or bounced checks.

Savings Account

This account will be your middle ground. Whatever is left over in your checking account after paying your bills for the month, put into a high-yield savings account. In the current financial market you can expect to receive an interest rate around 1.5% APY. Check for here for highest savings rates or on the bank websites. Then call to find out all the details of the accounts available.

Make sure to choose the highest yielding account that suits your needs.

Certificate of Deposit (CD)

A certificate of deposit is different from a savings account in that the CD has a specific, fixed term (generally varying from 3 months to 5 years), and a fixed rate. The money is locked in that account for the given period at the end of which you may renew the CD or withdraw your initial funds and the interest accrued. Keep in mind, should you need to pull your money out before your CD comes due, there is a penalty. The penalty will usually be about 30-35% of the total interest to be owned for the duration of the CD.

Interest rates are close to all-time lows. You will be hard pressed to find a rate above 2%. However, rates are always fluctuating and the trend should be for rates to go up from here. For that reason, my recommendation is to choose a 6-month CD. The 6-month CD is a good choice because it is a nice trade off between a short term and decent interest rate.

CD Ladder

You will want to split your CD fund into three portions. A third should be invested now into a 6 month CD. In two months, take another third and buy another 6 month CD at the highest possible rate. In another two months, invest the remaining fund into a third CD. This concept is called a CD ladder and allows you to have one third of your funds becoming fully liquid every two months and allows you to continuously capture increasing interest rates.

About the Author

By , on Feb 11, 2010
Josh is a Financial Service Professional who has spent many years trying to make the most of what he has and share his experiences to help others. His specialty is discussing the wants and needs that everyone seeks, but in a fiscally responsible way. To read more from Josh see: http://persfinanceguy.wordpress.com/ or visit him on twitter @PersFinanceGuy.

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Leave Your Comment (5 Comments)

  1. Bill Guard says:

    Although cash in a savings account doesn’t yield a good “return” (at current rates, it loses money after adjusting for inflation), it does provide the advantage of providing a liquid “cushion” in case you get hit with unexpected expenses. I wouldn’t think of this as an ‘investment,’ necessarily; I’d think of it as a line of defense.

    As you mentioned in the article, choosing a bank with an online portal is essential, because its the easiest way to manage your accounts. (You can also link your accounts online to a central place that monitors and tracks your account activity). Fortunately, almost all banks and credit unions have online portals these days.

  2. Andrew says:

    I agree with the checking account as a hub… one of the frustrating things about this is that banks charge money to move the cash to other banks – then they offer pitiful savings rates… I recommend just having a checking account hub but then open online savings accounts where you can pull money from your checking… Its a little more overhead in management, logging into separate accounts, but you can set up automatic withdrawals to make this easier… I don’t know about CD’s I have not seen a good comparison in the last few years that says CD rates trump savings rates in the online world. I would like to see an analysis in the past 5 years against ING and others… with rates so low and the economy unstable I would not recommend a cd besides – talk about overhead – if you forget the renewal date the cd renews… yikes!! and you are stuck for another time period… the analysis would have to account for this cost as well to be fair.

  3. Chris says:

    Josh, thanks for providing more clarity around which bank accounts and investments might make sense for the average American. As this is the first time I read your blog I checked out your bio. You have exactly the same philosophy as the company I helped found (www.investforless.com). We refuse all commissions and asset based fees and allow clients to purchase institutional mutual funds for a $250 annual membership fee. For the average retiree the savings is significant. Check us out! We’d love to hear your feedback!

  4. L. Hernandez says:

    “If any money remains (hopefully there is at least some), transfer those funds to a linked savings account.”
    “Whatever is left over in your checking account after paying your bills for the month, put into a high-yield savings account.”

    It’s taken me 20 years, but I have finally recognized that this approach doesn’t work well for me. The very first bill of the month is to the linked savings account, and then the other bills are paid — housing, utilities, etc. It’s hard, after all I get statements and calls from the other folks wanting my money, but if the savings comes after the other bills are paid, the savings are practically non-existent. Ideally it would be as automated as the 401k deduction. My company allows me to split my direct deposit among 3 bank accounts, so I recommend that.

    You can transfer the money back into checking should you need.

  5. Ken says:

    I like the CD laddering idea….now I just got to get some money to open one 🙂 Don’t we all.

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