How to Choose the Best Savings Account
Personal savings in America is dismal. In fact, the personal savings rate went from -0.5% in 2005 to -1% in 2006, the only negative years since the Great Depression. Some media pundits will argue that consumers don’t need to have traditional savings because their cumulative wealth is tied up in other assets (retirement plans, mutual funds, real estate, etc), which are suitable substitutes for basic savings. We strongly disagree.
In a previous discussion, we detailed How to Choose the Best Checking Account. Feedback was excellent, but many readers wanted more information about choosing the other critical bank account: Savings. As a result, we’ve put together some information on the second most important financial account everyone should have: an easily-accessible, high-yield cash account.
We Prefer “Cash Account”
Of course, we could have just come out and said a “High-Yield Savings Account”, but there are a few other high-yield options that also fit the bill. Having said that, for the average consumer, a high-yield savings account is the perfect solution. Here’s why…
Just In Case
For most people, the main purpose of a savings account should be to serve as an Emergency “Rainy Day” Fund. Let’s face reality; you just never know when a financial crisis will occur, and it is prudent for you to set aside some liquid money that you can tap if a financial crisis ever occurs. By liquid, we mean you should be able to access the money in a matter of days without incurring any penalty, loss of asset value, or transaction fee. These criteria rule out the certificate of deposit (CD), stocks, mutual funds, 401k, IRA, and the home equity loan/line of credit as emergency fund tools. Then you naturally ask, What If an Emergency Never Happens?
A Financial Tool…and Then Some
An emergency fund is equally as much an emotional and psychological tool as it is financial. The confidence and peace of mind you will have by knowing that you have some protection “just in case” is invaluable. And if you never need to use it, then lucky you! As a general rule, we recommend that you accumulate 3 to 6 months of living expenses inside of your Emergency “Rainy Day” Fund.
Online All the Way
When selecting a checking account, we gave you the option of brick-and-mortar versus online, but the savings account is a no brainer: Go online. As with the checking accounts, online savings accounts offer superior interest rates, equal FDIC protection, no fees, and fast transfers.
Our three favorite online savings accounts (and their APYs)
- E*Trade Bank (5.05%)
- Emigrant Direct Savings (4.75%)
- HSBC Direct Savings (4.50%)
Beyond Savings
For the savvy savers, a few other options exist:
Money Market Account (MMA) – Offered by banks and credit unions, the MMA is takes the higher-interest feature of the savings account and combines it with the check writing ability (usually up to a limit each month) and FDIC insurance of a checking account. Sort of like a TV/VCR/DVD combination unit, it does several things sufficiently…but none great (and the MMA will never eat your videotape). If minimizing the number of open financial accounts is your number one priority, then a money market account is worth a look.
Money Market Fund (MMF) – In contrast to the Money Market Account, a Money Market Fund is a product purchased through a brokerage. The same companies that sell stocks and bonds typically also offer mutual funds that invest in low-risk, highly-liquid securities. Money market funds typically invest in short-term government securities, certificates of deposits, and corporate commercial paper. Because MMFs place your money into open market financial instruments, investor losses are possible (although rare), and your money is not insured against these losses.
U.S. Treasury Bills - Issued and guaranteed by the U.S. Treasury Department, Treasury Bills (“T-Bills”) are considered one of the safest investments; additionally, they are exempt from state and local taxes. T-bills offer a quick and easy way for the U.S. government to raise money from the general public. Here’s how they work: Consumers bid on Treasury Bills at a reduced price (a “discount”) and—3 to 12 months later when the bill comes due—the government will repay the discounted price plus interest.
Monitoring Your Cash Flows
Analyzing cash flow is a simple process that helps you avoid the problems of a cash shortage. A cash crunch doesn’t necessarily mean you are broke, but it is a situation you should avoid if possible. Cash flow analysis is a common practice at most businesses, whether large or small. In fact, you’ll find a cash flow statement in every company’s annual report.
Why Bother?
Cash flows represent all of the money coming in and going out within a given time period, often a month, quarter, or year. Subtracting the total outflows from total inflows provides your “net cash flow” for the period.
Tracking Cash Flows Ensures Ongoing Financial Solvency
Tracking cash flow differs from tracking income and expenses. Cash flow analysis looks at when you actually receive or disburse money. Note that income is seldom received at the moment it’s earned because employers pay weekly, biweekly, or monthly. Similarly, buying with credit permits paying for goods or services after you receive them, sometimes long after. Surprisingly, it is possible to earn more than you spend and still have a negative cash flow.
Example(s): Janice, a popular family dentist, has a large, successful practice. Her success leads her to expand and modernize her office suite, a costly proposition. But her patients, feeling the impact of a slowing economy, are becoming ever later in their payments. While Janice has earned sufficient income to pay for her office renovation, she is falling short of the cash needed to make her monthly payments.
Compare Cash Inflows and Outflows on a Regular Basis
Cash flow analysis fulfills two purposes. First, it shows whether your money is coming in faster than it’s going out (preferable) or vice versa (highly undesirable). Additionally, it shows, at a glance, the inflows and outflows for a given period, thereby enabling you to quickly spot problem and opportunity areas.
What are Cash Inflows?
Cash inflows include all money actually received within the given period. The money can be in the form of cash or checks that you could cash or deposit in an account. The source of the inflow is irrelevant for a cash flow analysis. Sources could include tax refunds, rent received on investment property, dividends, capital gains, gifts, and even prize winnings.
Caution: If you receive loan proceeds as a check made out to you, it is a cash inflow. If the check is made out to someone else from whom you purchased goods or services, it is really their cash inflow, not yours. If you receive a check and endorse it over to someone else, it is technically an inflow plus a matching outflow, and it therefore has no effect at all on total cash flow.
What are Cash Outflows?
Cash outflows include all money disbursed within the period, whether by cash, check, or electronic funds transfer. If you withdraw money from a bank account, it is not technically a cash outflow until you spend it, but for practical purposes, it is often easier to consider it an outflow when withdrawn. When you write a check that will be paid from money in your account, it is a cash outflow.
Caution: Using credit to get cash (otherwise known as a cash advance) does not cause a cash outflow until you actually repay the lender. Many banks offer overdraft protection and other forms of credit closely linked to checking accounts. A check that draws on the bank’s money instead of yours is really credit, so it is not a cash outflow until you repay it.
What is Net Cash Flow?
Combining total cash inflow with total outflow for a selected period gives net cash flow. When outflows exceed inflows, net cash flow is negative. Conversely, a positive cash flow means that a cash surplus is accumulating. Typically, net cash flow is positive during your earning years and negative during retirement, when your nest egg provides your support. Cash flow alone tells just part of the story. Credit makes it easy to overspend, piling up debt even while cash flow remains positive (a common scenario that soon leads to problems).
Cash Flow Analysis is Just One Part of Your Complete Financial Picture
Cash flow analysis is one of several useful tools in budgeting. Together with an income/expense statement and a net worth statement, it can give a clear picture of your present financial situation. Reviewing these tools together usually reveals where changes can or must be made to achieve your short- and long-term budget objectives.
Reviewing Cash Flows Over Time Reveals Trends, Both Good and Bad
Calculating net cash flow for the most recent period tells you how you’re currently faring. Comparing cash flow analyses for a sequence of equal periods (e.g., the last 6 or 12 months) will reveal trends. Not only does this process show whether a trend is positive or negative, but how rapidly the situation is changing.
Tip: Save your cash flow analyses for future comparisons.
Identify Upcoming Problems in Time to Avoid Them
Projecting what your cash flow will likely be in the upcoming month, quarter, or year is an important aspect of budgeting. Once you’ve completed a cash flow analysis for the most recent period, use it as the basis for projecting the next. Estimate what the inflows and outflows will be, then combine them to get a net cash flow forecast. You will then learn whether your cash flow is likely to deteriorate or improve. You can then adjust some of the controllable items right on the worksheet to see how they alter the net cash flow forecast.
Tip: Computer software for spreadsheets and budgeting enables the making of changes with instant recalculation of results. Moreover, such software permits you to print a given page before making further changes. Still, a pencil, eraser, and calculator are nearly as fast if your changes aren’t too numerous.
Choose the Best Checking Account
The most basic and essential financial account everyone should have is a checking account. Unfortunately, according to the Federal Reserve’s most recent Survey of Consumer Finances, approximately 10 million U.S. households do not have a checking account at a bank or credit union. Ideally, everyone over 18-years-old should have a checking account in order to pay bills, track cash flow, and establish a track record with a reputable financial institution. We emphasize selecting an account with no monthly fees and accessible, no-fee ATM machines.
Should You Stay Local or Go Online?
Local Bank
This is the traditional national/regional “brick and mortar” banking institution with a branch on every corner of your community. As stated before, if you are going the local route, be sure to open an account with no fees (minimum balance, online bill pay, check-writing, etc.) and also ask about a sign up bonus. You can usually score a quick $25 or $50 deposit from these multi-national players since competition is so fierce for your banking business.
Online Bank
The digital scene continues to invade traditional spaces, and more of our financial advising clients are going virtual for their checking needs. Online checking accounts are more popular than ever due to their convenient, no-fee structure. Our three favorite online banks are:
Many of you probably noticed that all three of these banks wear names traditionally associated with investment brokerage accounts. Points for you! And if you take a look at each link, then you will also note that all three of these online banks will give you free personal checks, free online bill pay, and even refund all ATM fees…even those pesky fees charged by out-of-network ATMs!
Consumers Have High Interest
A major reason why the general public is flocking online is the lofty interest rates that online banks are dolling out to customers. All three of the online banks listed above offer an annual percentage yield (APY) of at least 3.5% (Note: E*Trade bank requires at least $5,000 in deposits to earn the high interest rate; Schwab and Fidelity do not.). This is compared to the national “brick and mortar” average of about 0.35%. And rest assured, as long as the FDIC protects your online deposits, you will take on no additional risk by leaving your local branch and going online.
On the downside, online banks likely do not have a major presence in your neighborhood, so local offices could potentially be hard to come by. In this case, if you do visit your bank’s local branches often, then an online account may not be your best bet. But come on, who actually goes inside of banks anymore?
Five Checking Account Tips
- Never pay an ATM fee again
- If you can’t find a network ATM, just make a small purchase at any grocery store, pharmacy, or post office and ask for cash back
- Use online bill pay whenever possible
- Most banks even allow you to use bill pay to send money to friends and family at no cost.
- Avoid mailing personal checks to pay bills
- For personal security and identity-theft protection
- Never have the following information printed onto your checks:
- Driver’s License #
- Social Security #
- Full Name (Optional)
-
- Just use your first initial and last name
- Check your account often
- The best way to minimize the effects of identity theft is to catch it early
- Watch your balances and report any suspicious activity to your bank immediately
- The best way to minimize the effects of identity theft is to catch it early
Budgeting 101: The Income and Expense Statement
July 6 by Justin
Filed under Banking, Keys_to_Shine
One of the most important steps in budgeting is reviewing income and expenses. Everyone knows that money tends to trickle out faster than it comes in, but often we lose track of how much goes where. An income and expense statement provides a snapshot that quickly shows your household’s spending pattern in relation to its total income. With it, you can make informed budget-adjustment decisions more easily. The income and expense statement may be done weekly, monthly, quarterly, or yearly
What Is It For?
The income and expense statement reports income earned and spent during a specified period. That period can be whatever best meets your budgeting needs. A period of several months to a year is often used to obtain a broad overview.
Comparing two or more income and expense statements is more meaningful when each reflects an equal time period (e.g., comparing one month to another or one year to another).
Example(s): Last year Zora left her old employer to join ABC, Inc. Her former employer paid Zora weekly, but ABC pays her monthly. If Zora’s income and expense statements were done weekly last year, they would need to be done weekly this year as well to do an apples-to-apples comparison.
Use the Income and Expense Statement to Estimate Future Income and Expenses
An income and expense statement can be used to forecast what you expect your income and expenses to be during some future period. It is a useful budgeting and financial planning tool. Although it is based on projected income and expenses, its accuracy is usually an adequate base for budgeting and planning purposes. Income and expense statements help identify problems and opportunities in budgeting.
As with cash flow analysis, you can compare income and expense statements for successive periods to learn several things. For example, you can learn which categories are increasing and decreasing, whether net income is shrinking or growing, and at what rate these changes are occurring. Net income–the amount of income you have left when all the bills are paid–increases your net worth.
Interpreting the Results: Are You Living Within Your Means?
If your expenses exceed your income, you have a negative bottom line or a “net loss.” That is, you are depleting your net worth, a situation that sometimes requires prompt and serious attention. Hopefully, you have a substantial net gain, meaning that your net worth is indeed growing. You can divide total expenses by total income to learn what percent of income you are spending. Compare this to previous periods to learn if your ability to grow your net worth is improving. The percent of income you spend or save is meaningful only to you and your own budget objectives. Certainly, a higher net worth will enable you to do more and live more comfortably in coming years.
A retirement plan contribution is not truly an expense item. It is income being saved for future use. However, such contributions are often viewed as expenses in a cash flow analysis and budget because that cash is temporarily unavailable for other needs.
Maintaining Your Financial Records
June 1 by Justin
Filed under Banking, Keys_to_Shine
More than ever, people are using their computers to prepare tax returns, monitor banking activities, and manage investment portfolios. In fact, many of our clients have completely eliminated the paper trail in their financial lives, preferring instead to receive and archive all financial statements electronically. But are electronic records adequate?
Paper vs. Electronic
Generally, an electronic record has the same worth as a paper record for tax and legal purposes. And the rules for how long you should keep electronic records are the same as for paper records.
But if you decide to go the electronic route, you must take extra steps to make sure your records are safe. This means keeping at least two copies of your electronic records: one copy on your hard drive and another copy on a removable hard drive device, an external data server, or burned onto a CD or DVD. In fact, even if you have paper records, if you own a scanner, you might consider digitizing important records into your computer. If you need help deciding how to organize your documents, your local computer retailer offers software designed to simplify financial record keeping.
Many banks and financial institutions now keep electronic images of your financial records, such as monthly canceled checks or quarterly brokerage statements. If you don’t download important items and save them on your own computer, inquire about the institution’s policy on how long it will store your records, and how you can access them if you need them. You wouldn’t want to lose a tax deduction because your bank didn’t keep an electronic image of a canceled check for a sufficient period of time.
How Long Should You Keep Financial Records?
Tax records–We recommend keeping your tax records for up to seven years. This is because the IRS has three years from a tax return’s due date to challenge your return, and it has up to six years to challenge your return if you’ve underreported your income by 25% or more in a given year. The tax records you should keep include statements related to wages, deductions, dividend or interest income, capital gains or losses, and business profits. As for the actual tax returns, it’s a good idea to keep copies indefinitely.
Retirement records–You should keep year-end 401(k) account statements at least until you retire, along with any rollover paperwork. Similarly, you should hold on to records that detail your IRA contribution and withdrawal activity–year-end statements should suffice. Also, keep copies of tax forms related to your IRAs until all money is withdrawn from the accounts.
Investment records–When you purchase stocks, mutual funds, and other investments, you need to keep records relating to how much you paid (i.e. “cost basis”) so you can document the amount of gain/loss when you sell the asset. You should also keep paperwork showing periodic purchases or the reinvestment of dividends related to the asset, if applicable (again, year-end statements should suffice). When you sell the investment, the records should be kept for up to seven years according to the rules above for tax records.
Home improvement records–If and when you sell your home, you’ll need to calculate the costs of any permanent home improvements that you’ve made for tax purposes. So make sure to keep copies of all work invoices and canceled checks related to your home.
It’s All on Your Shoulders
While electronic records can help cut down on the volume of financial paperwork you need to store in your filing cabinet, it’s your responsibility to make sure you can access all records–paper and electronic–if and when you need them.
The Best Online Bank for You
Some of the most common questions that we continue to receive relate to your selection of stock brokers, insurance companies, and savings accounts. Today we’ll tackle the last point…how exactly do you find the best place to stash your savings? In two words: Go online.
Selecting the best place for your short-term money
Over at Money, Matter, and More Musings, Golbguru has an informative post detailing what he looks for in a savings account:
- Easy synchronization with other bank accounts
- High interest rates
- No fees
- FDIC insured
But what is “FDIC Insured”? And how much interest is acceptable?
If you feel as though you’re still kind of lost with the terminology and concepts, then you need a to check out Bankrate.com, one of the most trusted financial sites on the Web. They provide consumer tips, definitions of terms, and even real-time rates for savings accounts, credit cards, and mortgage loans.
Mama used to say
Of course, slick marketing pages and fancy websites are one thing…but word-of-mouth from trusted people is usually the most effective form of endorsement. So be sure to ask your friends and family members about their experiences with various banks and credit unions. You may be shocked to learn just how easy it is to earn an impressive 5% interest rate on the dollars that are currently asleep in your checking account.
How to Establish Savings & Investment Goals
Go out into your yard and dig a big hole. Every month, throw $50 into it, but don’t take any money out until you’re ready to buy a house, send your child to college, or retire.
It sounds a little crazy, doesn’t it? But that’s what investing without setting goals is like. If you’re lucky, you may end up with enough money to meet your needs, but you have no way to know for sure.
How do you set investment goals?
Sit down, and define your dreams for the future. If you are married or in a long-term relationship, spend some time together discussing your joint and individual goals. You can do this on your own or with the help of a financial advisor. For this exercise to be most effective, you should be as specific as possible. For instance, you know you want to retire, but when? You know you want to send your child to college, but to an Ivy League school or to the community college down the street?
You’ll end up with a list of goals. Some of these goals will be long term (more than 15 years), some will be short term (5 years or less), and some will be intermediate (between 5 and 15 years to plan). You can then decide how much money you’ll need to accumulate and which investments can best help you meet your goals.
Looking forward to retirement
Retirement may seem a long way off, but it’s never too early to start planning–especially if you want retirement to be the good life you imagine.
Here are some points to keep in mind as you set specific retirement investment goals:
- Determine how much money you’ll need in retirement: We generally advise that you’ll need about 75 to 85 percent of your current income to maintain your standard of living
- Plan for a long life: According to life expectancy charts, you can expect to live for 15 to 20 years past retirement, assuming you retire at age 65
- Think about how much time you have until retirement, then invest accordingly: For instance, if retirement is a long way off and you can handle some risk, we recommend investing in stock or equity mutual funds which, although more volatile, offer a higher potential for long-term return than do more conservative investments
- Consider how inflation will affect your retirement savings: When determining how much you’ll need to save for retirement, don’t forget that the higher the cost of living, the lower your real rate of return on your investment dollars
Facing the truth about college savings
Perhaps you faced the ugly truth the day your child was born. Or maybe it hit you when your child started first grade: You only have so much time to save for college. In fact, for many people, saving for college is an intermediate-term goal–if you start saving when your child is in elementary school, you’ll have 10 to 15 years to build your college fund. Once again, the earlier you start the better. The more time you have before you need the money, the greater chance you have to build a substantial college fund due to compounding. With a longer investment time frame and a tolerance for some risk, you might also be willing to put some of your money into investments that offer a higher potential for growth.
Your financial advisor and you should also seriously consider these points as well:
- Estimates of the average future cost of tuition at two-year and four-year public and private colleges and universities are widely available. Note: Your financial advisor should be able to estimate the present value (today’s cost) of your child’s future education, based upon projected inflation rates and expected rates of returns for your college-fund investments)
- Research financial aid packages that can help offset part of the cost of college: Although there’s no guarantee your child will receive financial aid, at least you’ll know what kind of help is available in case you need it
- Look into state-sponsored tuition plans that put your money into investments tailored to your financial needs and time frame: For instance, most of your dollars may be allocated to growth investments initially, then later as your child approaches college, into more conservative investments to conserve principal
- Think about how you might resolve conflicts between goals: For instance, if you need to save for your child’s education and your own retirement at the same time, how will you do it?
Investing for something big
At some point, you’ll probably want to buy a home, a car, or the 30-foot fishing boat that you’ve always wanted. Although they’re hardly impulse items, large purchases are usually not something for which you plan far in advance–one to five years is a common time frame.
Because you don’t have much time to invest, you’ll have to budget your investment dollars wisely. Rather than choosing growth investments, you may want to put your money into less volatile, highly liquid investments that have some potential for growth, but that offer you quick and easy access to your money should you need it.
Speaking of investing for growth, one of our favorite bloggers, J.D. over at Get Rich Slowly, has a wonderful analysis of what he calls the “Three Enemies of Growth”. His article is certainly worth a read for anyone interested in overcoming the most common obstacles for savers and investors.
Building a Financial Safety Net
In times of crisis, you don’t want to be stranded, shaking coins out of a piggy bank. A financial safety net–often called an “emergency fund”–can ensure your protection if when these crises occur. An emergency fund is a cash reserve, which can be quickly tapped for unexpected events…you know, like a new transmission, a serious medical procedure, or even the loss of a job.
How much is enough?
We suggest that you have three to six months’ worth of living expenses in your emergency fund. The actual amount, however, should be based on your particular circumstances. Do you have a mortgage? Do you have short-term and long-term disability protection? Are you paying for your child’s orthodontics? Are you making car payments? Other factors you need to consider include your job security, health, and income. The bottom line: Without an emergency fund, you could be financially blindsided by an unexpected event.
Building your cash reserve
If you haven’t established an emergency fund, or if the one you have is inadequate, don’t panic. You can take many steps to get started:
- Save aggressively: If available, use payroll deduction at work; budget your savings as part of regular household expenses
- Reduce your discretionary spending (e.g., eating out, movies, lottery tickets)
- Use current or liquid assets (those that are cash or are convertible to cash within a year)
- Use earnings from other investments (e.g., CDs, stocks, mutual funds)
- Check out other resources (e.g., do you have a cash value insurance policy that you can borrow from?)
A final note: Your credit line can be a secondary source of funds in a time of crisis. This is often advised for younger clients and students. Be cautioned, however, that this money will of course have to be paid back (often at high interest rates). As a result, we do not recommend lenders as a primary source for your cash reserve.
Where to keep your cash reserve
Jonathan, over at MyMoneyBlog, posted a wonderful analysis of various high-interest, short-term accounts. We strongly suggest reviewing his findings. The key is to make sure that your cash reserve is readily available when you need it, earning the highest rate of interest in the meantime.
Review your cash reserve periodically
Your personal and financial circumstances change often–a baby is born, an aging parent becomes more dependent, or a first home brings increased expenses. Because your cash reserve is the first line of protection against financial devastation, you should review it every six months to make sure that it continues to fit your current needs.
Hello World!
April 1 by Justin
Filed under Banking, Credit & Loans, Education & Work, Family & Home, Investing, Keys_to_Shine, Retirement
As Lightship Mutual joins the ranks of the online blogosphere, we look forward to providing insightful wit and biting commentary into today’s social, political, and technological events as they relate to your personal finances.
Mission: Blog
The Daily Compass represents the ongoing thoughts, musings, and opinions of the advisors of Lightship Mutual. This forum serves to compliment our monthly newsletter, ‘The Lightship Compass’. If you are not yet on our email list, click here to begin receiving our monthly publication, as well.
Staying true to our overall company’s mission, we believe that this forum belongs to you. We fully anticipate a heavy involvement from our site visitors, and we look forward to providing accurate, clear, fast responses to your questions and comments.
Here Comes the Neighborhood
As the new kids on the blogosphere block, we’re happy to be a part of your community. We promise: a well-manicured lawn, no loud music, and we’ll only decorate the backside of our house with pink and green shutters. So feel free to drop by anytime with some fruit cake, punch, or any other treats from the welcome wagon. There are always interesting conversations around here, and we are truly excited to be a part of your online experience.