Personal Finance 101: Getting Started with Banking

We all did it at the beginning of our financial lives. We grew up. We moved out. We opened accounts at a bank on our own, quite often a different bank than the one used by our parents.

And we had to figure it out. How should we pick a bank? How do we move the money over? What should we put in our checking account? Our savings account? What are these CD things?

Michael writes in:

I’m a student, just trying to firm up my financial situation after having read your blog. For the last several years, I’ve used Washington Mutual largely because my parents had an account there but since being taken over by Chase, customer service has gone downhill, and the interest rate on my savings account is ridiculously low.

I’m looking at having an interest-bearing checking account and a savings account at different banks, to maximize my savings. However, how easy is it to transfer money from an account at one bank to one at another? Also, I’ve seen money market accounts, savings accounts, and no penalty CDs? What’s the difference, and how would you allocate money between them?

My first comment would be that I would value customer service strongly at the bank where I held my checking account, but view it as more of a secondary factor at the bank where I held my savings account. The bank with the checking account will handle the vast majority of your transactions for you, while the savings account bank will just handle a small number. So, when you evaluate your checking account bank, ask around and Google for information on their customer service.

Transferring Money Between Accounts
How does transferring money between accounts at different banks work? If a bank features online banking, it’s usually just as easy as logging on and requesting such a transfer. Most likely, if you’re seeking a high-interest savings account, you’ll be getting an account that’s managed primarily online, as most of the best interest rates are offered by online banks such as ING Direct, HSBC Direct, and so on.

In those cases, the online account is often “linked” to your checking account. That means you record the information about your checking account (the account number and the bank’s routing number, which you can get from them upon request or often simply from their website or from Google. Once that’s set up, you will be able to initiate transactions either way – both from checking to savings and from savings to checking – with just a few mouse clicks.

Such transactions are done electronically and usually take around two business days to complete.

Choices for Savings
Michael also wondered about several different options for saving his money. Let’s look at them.

Savings accounts are the default choice. Savings accounts allow you to deposit money as you please and withdraw money up to six times a month. Savings accounts usually have a fixed rate of return that doesn’t change all that often. Usually, high interest savings accounts change their rates whenever the Federal Reserve changes rates, so if you hear about Ben Bernanke on the news, pay attention to your rates.

Money market accounts sometimes offer a higher rate of return than straight savings accounts, but the rate of return on a money market account is variable and is quite often not as high as the online offerings. It changes based on the state of the money market – to put it simply, the money you put into that account is invested by the bank in highly secure government investments. Those investments change rates regularly (based on what the government is offering at a given time, which is usually related to the demand of the market) and thus the rates you get in the account go up and down. On (extremely) rare occasions, money markets will return nothing at all or just a tiny, tiny fraction of a percent – at other times, they’ll blow savings accounts away. Most of the positive legacy of money market accounts comes from the early 1980s, when they returned money hand over fist because treasuries had absurdly high rates of return.

CDs are much like savings accounts, except they have a higher rate of return. The big difference is that you can’t actually touch the money you’re saving during the life of the CD. So, if you picked up a one year CD with a sweet interest rate that’s much higher than your savings or money market options, you wouldn’t be able to touch that money for a year without a stiff penalty. The “no fee” part you mention is something that’s offered by a lot of banks today – the days of charging fees to buy a CD are rolling into the past.

Splitting Up the Money
So what should Michael do?

In my experience, money market accounts and online savings accounts are usually very comparable. If anything, I’ve consistently seen online savings accounts offer a slightly larger return over the years I’ve been following them, but money market accounts at your local bank will likely trounce their savings account rates.

When compared rates between maoney market accounts and online savings accounts are close (say, within half a percent or so), I generally stick with banks that have a good customer service reputation, but I don’t view it as being as important as it is with my primary bank that holds my checking account and handles most of my transactions. Rate-hopping (or rate arbitrage, as some call it) isn’t worth the effort, in my opinion, unless you’re moving around high five-figure or six-figure amounts, in which case I wouldn’t have a large portion of that in a savings account.

What about CDs? CDs can be a really great way to tack on a bit more return for your savings, but it’s often easy to get caught up in CDs and put more of your savings into it than you should. I would make sure that I had a healthy emergency fund in my cash savings (a savings account or a money market account). If you’re single, this would probably be about two months’ worth of living expenses. The ability to just grab cash when you need it to deal with an emergency is vital.

The big question I’d ask myself is why I would want to put money in CDs. This goes beyond just earning a higher rate of return – if you just want that, put the money in a CD that will mature within a year and keep recycling it (unless you have a year or more worth of living expenses in your savings account, then you can shoot for longer ones). Are you saving for a particular goal? When do you expect that goal to come to fruition? If you have a goal in mind, buy the highest rate CD that matures before that goal.

Of course, if you’re finding that you want to get more aggressive with saving for goals, you can begin to look into index funds… but that’s another story entirely.

Good luck, Michael.