Savings accounts, which are offered by banks and credit unions, are very convenient ways of storing your money. Deposited funds are insured by the Federal Deposit Insurance Corporation (or the National Credit Union Administration for credit union accounts) for up to $100,000 total for all accounts in your name, so there's little risk of losing your money. Although they usually pay a relatively low rate of interest – some as low as 1 percent or less – the range of interest rates offered by competing institutions can be quite wide. It's possible to find savings accounts that pay in excess of 5 percent; so shopping around is definitely be worth the time and effort.
There are two main types of savings accounts: passbook and statement accounts. The older passbook accounts (which some banks no longer offer) issue account holders a small book in which the balance and all transactions including interest are recorded by the bank. In lieu of a passbook, statement accounts provide a monthly or quarterly statement of all account activity. The statement can either be mailed in conventional form or delivered electronically for Internet users.
Some banks offer several levels of savings accounts, with the higher or 'premium' accounts paying more interest but requiring that you maintain a minimum deposit amount. When comparing, be realistic about whether or not you'll be able to maintain the minimum balance if one is required. If you think it might be a problem, opt for a lower account that doesn't have balance requisites, or shop at another bank. Fees – often in excess of the interest the account pays you – can be charged if your balance dips below the minimum. The rules regulating these fees can be fairly extensive and vary from bank to bank.
Another reason for the importance of comparison-shopping when looking for a savings account is that different banks have different methods of computing the interest that they pay. For instance, Bank A may advertise that it compounds interest, which means its account holders earn interest on the interest that's already been paid to them, as well as on their principal balance. On the other hand, Bank B states that its pays simple interest; in other words, they pay interest only on the account's principal and not on any interest that's already accrued.
As you can probably guess, compounding interest is a better deal. A rate of 3 percent simple interest paid annually is just that – 3 percent, or $30 on a $1,000 balance. But 3 percent compounded interest is higher – exactly how much higher depends upon how often it's compounded – because it will include interest on the $1,000 principal along with interest on the interest previously earned. The larger your savings and the longer you leave it to compound, the more you'll earn.
Additionally, savings accounts can start to earn interest at different times, depending on the institution. Some banks pay interest based on an average daily balance. This method pays interest only on the smallest balance that you have in your account during the interest period. In some cases, you'll earn a lower rate if your balance drops below a predetermined minimum. Shop for a bank that pays from the first day of deposit until the day of withdrawal, so that you'll earn interest for the full time the bank has your money. Remember, banks are in fierce competition with each other for your dollars; compare all account and bank terms to assure that you get the best deal available.
