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A
Starter Savings Account
by
Gary Foreman of The
Dollar Stretcher
Dear
Gary,
My wife and I have been married for 5 months and I am still a
college student. We
are trying to decide how to best invest the extra money we have
each month while she still works, so that when we do have kids,
she can stay home with them.
Our plans are to pay off our car ASAP to get rid of that
bill. I was wondering how to get the most out of my savings.
What is a 'money market account' and what type of low-risk
investing do you suggest? There
has got to be something better that the old fashioned savings
account that makes 2 or 3%.
Mike
Sounds
like Mike and his bride are off to a good start. They've looked
at their situation, decided where they'd like to go and have
headed off in that direction. So let's see if we can't help them
with a starter savings plan.
To
answer Mike's first question, there are two different types of
accounts commonly known as "money markets". The first,
a "money market account" is offered by banks, savings
and loans, and credit unions. These accounts are government
insured just like your savings account. You'll be allowed only
six withdrawals each month. And you can expect to earn more than
if your money were in a passbook savings or interest bearing
checking account.
Rates
paid by money market accounts will vary quite a bit. That's
because some banks are aggressively seeking funds and others are
not. If you have a money market account you'll need to monitor
your interest rate to make sure that it hasn't suddenly dipped.
You
will also find some money market accounts that invest in tax
free instruments. But, they're designed for someone in a high
income bracket. Not for folks like Mike.
The
second type of account is actually a mutual fund. Accordingly,
it's called a "money market fund". Each share is worth
$1.00. The shares will not go up or down in value.
Monies
in the fund are lent to high quality corporations to earn
interest. Although your principal is not government guaranteed,
there is almost no risk involved. Especially in stable economic
times.
Unless
you feel that you need the government insurance, you can select
either a money market account or fund based on rate and the
other features offered. Typically the average money market fund
will pay a little more than an average money market account. But
you're not investing in the 'average'. You're picking a specific
account. So you'll need to compare yields.
Some
financial institutions will offer a higher interest rate if you
allow certain restrictions. For instance, you might have to
maintain a higher minimum in the account. You'll need to
consider your situation to find out which offer is best for you.
Watch
out for fees when using an ATM to withdraw your money. Depending
on the account there could also be fees for writing too many
checks or letting your balance dip below a certain level.
Despite
some fees, money funds are a great place to keep basic savings.
That's because your money is safe. It's readily available if you
need it for an emergency. You can add small amounts frequently.
And money markets can grow surprisingly quickly if you let the
interest earned stay in the account.
Currently
Mike will find money funds yielding between 4 and 6% annually.
Certainly better than the savings account, but perhaps he'd like
something that pays even more.
That's
when Mike will come across a concept called "risk vs.
reward". To get a higher reward (i.e. interest rate), he'll
need to accept more risk.
Let's
be clear. We're not saying that anything that pays more than a
savings account is risky. A money fund is a very safe
investment. But, it does carry just a tiny bit more risk. And,
as different investments offer greater returns, they'll be
riskier.
So
what's a good choice for Mike besides a money market? The
highest rate of return on a safe investment for most people is
an easy one. That's to pay off their debts. For instance, if
Mike's car loan is at 10%, then that's what he'll earn on the
money that he uses to prepay that loan. It's guaranteed. And
there's no risk of losing his principal. Repaying credit card
debt has an even greater rate of return.
I
know that some of you will disagree. Some would tell Mike to
save money for an emergency. And, yes, he could be in a position
to need money later due to an unexpected bill. But then he'd
just use the credit cards to cover the emergency. In either case
he'd end up in about the same position.
Once
Mike's bills are paid he might want to consider investing in
certificates of deposit (CD's). They will pay more than money
markets, but offer less flexibility. Even a 6 month CD will pay
about 1 1/2% more than a money fund. But if you need to use the
principal before the CD's due date you'll face a penalty.
Before
we leave the subject, let's take a moment to look at strategy.
Mike is wise. Setting and achieving goals is important to his
financial future. The thought of being without an auto loan will
spur Mike and his wife to accomplish their goal. And once
they've achieved that goal, they'll be more confident in
choosing another. Next they might want to save for the down payment
on their first house. Or maybe they'll pay cash for the next
car.
Mike's
family has a good beginning. If they want "future mom"
to stay home when babies arrive, now is the time to begin to
make that a reality. This is the time to learn to live on one
income. After all, if the two of them can't live on one income
now, how will three be able to do it later?
All
the best to Mike and his wife. We wish them a wonderful life
together.
Gary
Foreman is a former Certified Financial Planner who currently
edits The
Dollar Stretcher ezines and website. You'll find
hundreds of free articles to stretch your day and your budget.
Visit Today!
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