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You have your basic checking and savings accounts—beyond that, how can different types of accounts serve your savings goals? What’s the smartest way to stash your hard-earned funds? We’ve recommended before that dividing your money into multiple accounts helps you see all your saving goals separately, so they’ll be easier to track. The money set aside for emergencies goes to a different account than your dream vacation fund, and so on.
Of course, if you’re living paycheck to paycheck, you might be hesitant to divvy up your savings in multiple accounts. However, a tough economy is exactly when building up your savings should be a priority. It’s important to understand the basics of all the options out there for you, depending on how much you can afford to save right now. So, whether you’re a lifelong saver or have extra cash for the first time, here are the different types of savings you should consider to reach your goals.
Emergency fund
Distinct from your other savings, an emergency fund is the cash reserve set aside exclusively for unplanned expenses or financial hardship, like job loss, medical emergencies, or sudden urgent car or house repairs.
The typical rule of thumb is to aim for six months’ worth of living expenses in your emergency fund. However, as we recently covered, you might update your emergency fund to include nine months’ worth of take-home income stashed away.
When you’re figuring out the number that’s right for you, factor in expenses like housing, food, utilities, insurance, transportation, and debt payments. Non-essential expenses like vacations, entertainment, or dining out don’t belong in your “emergency” calculations.
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Retirement accounts
After you establish your emergency fund, you want to make sure you’re saving for retirement. The two primary vehicles to get started are an IRA and a 401(k).
There are two main types of IRAs: Traditional and Roth. In the simplest terms, with Roth IRAs, you pay taxes on your savings now. With traditional IRAs, you pay taxes later. We’ve written about the differences in more detail here, and we generally lean pro-Roth over traditional.
A 401(k) is a retirement savings account offered through your employer with significant tax benefits. With a 401(k), the money you set aside isn’t just saved, but invested. You have the option of investing in a variety of assets like stocks, bonds, and mutual funds. Your funds get stashed away tax-free until you withdraw it, ideally after years and years of growth. If your workplace offers a 401(k), aim to contribute 10% to 20% of your paycheck.
Here are our guides to opening an IRA and opening a 401(k).
High-yield savings account
When you’re ready to start saving for goals a few years in the future, but certainly sooner than retirement, you might be interested in a high-yield savings account. Even when interest rates on your savings account are low (and they are increasing now), a high-yield savings account is a savvy way to get some returns on funds you know you’ll be accessing in the next one to five years.
Think about it like this: If you deposit $500 into a run-of-the-mill savings account, you’ve earn $0.50 in interest in one year. With a high-yield account with 2% APY, you will earn $10 on that $500—and with more time and more money, that interest adds up.
Here’s our guide to choosing a high-yield savings account.
Top alternatives to high-yield savings accounts
If you’re interested in earning higher interest rates than a regular or even high-yield savings account, your primary options are money market accounts and certificates of deposit.
Money market account
A money market account (MMA) is a way to earn higher interest rates than you would with a regular savings account. MMAs are notable for coming with the features of a checking account, like debit cards and limited check-writing privileges. However, MMAs are not ideal for people starting out with smaller savings, since they require a higher minimum balance than most savings accounts (usually between $5,000 to $10,000).
Certificate of deposit
A certificate of deposit (CD) is another vehicle for you to earn interest on your savings. They’re different from a traditional savings accounts because they’re time-based, usually offered in terms ranging from three months to five years. Longer terms come with higher interest rates. However, if you withdraw your money from the account before the set time period, you pay a penalty.
The bottom line here is that top-paying CDs pay higher interest rates than high-yield savings accounts or MMAs, but the trade-off is leaving those funds untouched for a fixed period of time. MMAs offer greater access to your funds, while a CD is the choice for someone who doesn’t need to access their savings for a set term.
Specialty savings accounts
For savers who want accounts tailored to specific savings goals, there are specialty savings accounts. You might set up an education savings account or a kids’ saving account for children under the age of 18. These accounts may have restrictions on who can open them, allowing you to ensure this money is set aside for a singular purpose. You should be able to find most of these accounts at banks, credit unions, brokerages, or investment companies.
If you’re interested in getting started with multiple savings accounts, Nerdwallet has a good selection of online banks you could choose from here.
