Saving money is an essential habit for building financial security and reaching your goals. But if you’re new to saving, some of the terms you’ll hear might be confusing. Here are some key terms to know.
General Savings Terms
Interest: This is the amount of money paid to you for allowing another entity to use your money. It’s typically expressed as a percentage. For example, if you have $1,000 earning 3% interest per year, you’ll have earned $30 in interest after one year.
Annual Percentage Yield (APY): APY is a common measurement to compare the total amount of interest earned on your savings over a year, including compound interest. Simply put, APY is the interest earned on both your initial deposit and previous interest payments. The higher the APY, the more you earn. Note: Annual Percentage Rate (APR) is the rate on your agreement, while APY considers compound interest.
Compound Interest: Compound interest occurs when you earn interest on the interest already received from your initial savings amount. Additionally, different compounding periods are offered – ranging from daily compounding to annual compounding.
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Example: You deposit $1,000 in a five-year CD that compounds monthly and offers an annual interest rate of 4%. The first year, you’ll make $40.74. Going forward, that $40.74 will also earn interest along with your original $1,000. By the end of the fifth year, your CD will be worth $1,221. That means you earned $221 thanks to compound interest. (For more on compound interest, see this article.)
Short-Term Savings: Whether you’re saving for a vacation, a bike, an outfit, or a new appliance, a short-term savings plan will help you set aside money to make purchases in the near term without taking on non-essential debt. These plans should be relatively easy to accomplish within a year or so.
Mid-Term Savings: A mid-term savings plan focuses on bridging the gap to long-term financial success. These goals typically cover the next three to five years, and can include a down payment on a house, a college education, a new car, or a wedding.
Long-Term Savings: A long-term savings plan focuses on saving money for your goals that are usually 10 years or more into the future. Most people's biggest long-term financial goal is saving enough money to retire.
Emergency Savings: This type of savings should be set aside for any unforeseen event that could be a risk to your finances. Most of us should have at least three to six months of living expenses in a liquid, no-risk financial product, like a savings account at a bank or credit union. (For steps on building your emergency savings, see this article.)
Liquidity: Liquidity measures access to your cash. The easier it is to withdraw your money, the more “liquid” it is. Accounts with high liquidity (like checking or savings accounts) are good for money you’ll need immediately. Accounts with lower liquidity (like CDs, stocks, or bonds) work better for money you don’t need right away.
Ways to Save
Savings Account: A savings account is a type of bank or credit union account designed to hold money for future short-term needs. The bank or credit union pays you interest for keeping your money with them. Account structures and offerings will vary from institution to institution, so do your research. Accounts are typically insured against loss to a specified amount.
Checking Account: Checking accounts are best for everyday transactions, such as paying bills, making purchases, or receiving direct deposits. Debit cards are typically offered with checking or money market accounts. However, not all offer both debit cards and checks, so do your research. (Note: An overdraft occurs when you spend more than what’s available in your bank account, which may result in fees.)
High-Yield Savings Account: These accounts are like traditional savings accounts but often with higher interest rates and different terms, allowing your savings to grow faster.
Money Market Account (MMA): An MMA usually offers a higher interest rate than a standard savings account but may require a higher minimum balance. MMAs typically allow limited withdrawals per month or per quarter, as well as some check-writing privileges.
Certificate of Deposit (CD) or Share Certificate: A CD at a bank – referred to as a “share certificate,” “certificate account,” or “certificate” at a credit union – is a type of savings account in which you agree to leave your money at the institution for a fixed period (maybe six months, one year, or five years). Rates are usually higher than typical savings accounts, but generally offer less withdrawal flexibility. If you withdraw your funds early, you’ll be charged a penalty unless otherwise noted.
Treasury Bills (T-Bills): T-Bills are short-term government bonds issued by the U.S. Treasury that mature in one year or less. They’re considered a safe way to save money because they’re backed by the federal government. Instead of earning traditional interest, you buy T-bills at a discount and get the full face value when they mature. T-bills can be purchased through a bank, a brokerage account, or TreasuryDirect.
Other Key Terms
FDIC Insured: Your bank deposits are protected by the Federal Deposit Insurance Corporation (FDIC), up to a certain limit, in the event of a bank failure, ensuring your money is safe. Under current law, deposits are insured up to at least $250,000 per depositor, per insured bank, per ownership category. (You can check if a bank is FDIC insured by using this tool.)
NCUSIF Insured: The equivalent of FDIC insurance for credit unions is the National Credit Union Share Insurance Fund (NCUSIF), administered by the National Credit Union Administration (NCUA). This insures deposits at federally insured credit unions, providing coverage of up to $250,000 per depositor, per insured credit union.
