When saving money actually costs you more

December 9, 2010

You will often hear the advice, “the more you save, the more you earn”, but is that necessarily true? Can putting too much into your savings account be bad for you, or is it just a myth that retailers want you to believe?

According to the latest ING Direct Financial Wellbeing Index, the average household income is $71,140 with an average of $8912 in savings. If we compare this to big savings goals such a $20,000 deposit for your first home (which is 5 percent of a $400,000 mortgage), it could take many years to reach.

Many experts argue that saving can be profit foregone from opportunities such as participating in a recovering stock market, or paying down debt. While it’s hard to predict your returns from stock investments, fund managers will often show the long-term gains from stocks to be above interest rates on savings accounts.

A guaranteed method of gaining profit from your savings is by paying off your debts that attract higher interest rates. For example, if you had $10,000 in an online savings account earning 5 percent per annum, and a car loan debt balance of $20,000 at 12 percent per annum over five years. If you transferred your $10,000 in savings and put it towards the car loan, you will lose about $2800 in interest from the savings account but would save $3350 in debt repayments, earning you $450.

But what if you’re debt-free and simply saving for a rainy day? This is the case for many retired Australians, who have finished paying off their mortgages and other debts.

There is no “rule of thumb” for how much everyone should save. However, if you’re debt-free and want a savings option that guarantees you the highest returns on the market, you can compare online savings accounts for rates as high as 6.51 percent by UBank‘s USaver(current as at December 9, 2010).

Term deposits are also a great option for those that have a large chunk of cash sitting around. For instance, you could earn 7.30 percent interest with a five-year term from Bank Of Cyprus (as at December 9). With a $50,000 deposit, that could earn you a smooth $21,000 after five years (not compounding).

If you think you’re saving too much, consider ways to make a profit from spending, such as paying down debt or investing. But remember that saving should always be tailored to your goals, so make sure that your savings account is always working to please your needs, and not the other way around.

 

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Learn more about savings accounts

How much money should I have in my savings account?

A good rule of thumb when working out a minimum balance for your savings account is to make sure that you’ll earn more in annual interest on your savings than what you’ll be charged in annual fees.

If you’re saving with a specific goal in mind, prepare a budget so the interest you earn on your deposits will help you efficiently reach this goal. Online financial calculators may be helpful here.

How to make money with a savings account?

Savings accounts make you money by earning interest on your savings. The more money you deposit, the longer you leave it in the account, and the higher the account’s interest rate, the more interest you’ll be paid by the bank or financial institution, and the more your wealth will grow.

To make sure your savings account makes money and doesn’t lose money, it’s important to maintain a large enough minimum balance that the annual interest earned exceeds any annual fees charged on the account.

Can you set up direct debits from a savings account?

It’s not usually possible to set up a direct debit from your savings account to cover ongoing expenses or bills, as savings accounts are structured around growing your wealth by earning interest on regular deposits, and discouraging withdrawals.

Some transaction accounts allow you to set up direct debits and also earn interest, though you may not enjoy as much flexibility as a dedicated transaction account, or get as high an interest rate as a dedicated savings account.

What is a savings account?

A savings account is a type of bank account in which you earn interest on the money you deposit. This makes it one of the easiest and safest investment tools.

Can you set up a savings account online?

Yes. Several large and small banks offer online applications for savings accounts, and there are also online-only financial institutions to consider.

Online-only savings accounts are often less expensive than other savings accounts, though they may not offer the same flexibility, features, or face-to-face service as more traditional savings accounts.

How to open a savings account for my child?

Some banks and financial institutions allow parents to open a bank account for their child as soon as it is born, and start depositing funds to go towards the child’s future.

Children’s savings accounts generally don’t have fees, and are structured to help develop positive financial habits by limiting withdrawals, encouraging regular deposits, and earning interest on the savings, similarly to standard savings accounts.

How does interest work on savings accounts?

The type of interest savings accounts accrues is called compound interest. Compound interest is interest paid on the initial deposit amount, as well as the accumulated interest on money you have. This is different from simple interest where interest is paid at the end of a specified term. Compound interest allows you to earn interest on interest at a higher frequency. 

Example: John deposits $10,000 into a savings account with an interest rate of 5 per cent that he leaves untouched for 10 years. At the end of the first year he will have $10,512 in savings. After ten years, he will have saved $16,470.

What is the interest rate on savings accounts?

As banks frequently change their rates, the most accurate way to look at interest rates on savings accounts is to use a savings accounts comparison tool. When you look at the savings rate check what the maximum and minimum rates are. Often banks will offer you a promotional rate for the first few months which is competitive, but then revert back to a base rate which can sometimes be less than inflation. Ongoing bonus rates are often a safer bet as they will keep rewarding you with the maximum rate, provided you meet their criteria

Can you have a joint savings account?

Yes. Joint savings accounts can be useful for two or more people wanting to combine their savings to meet shared financial goals, including spouses, flatmates and business partners.

Some joint savings accounts require all parties to sign before they can access the money. While less convenient, this extra security can help encourage all parties to meet their shared financial goals.

Other joint savings accounts allow any of the account holders to access the money. These accounts can be convenient for financially responsible couples that trust one another implicitly. 

Who has the highest interest rates for savings accounts?

As banks frequently change their rates, the most accurate way to know who currently has the highest interest rate is to use a savings account comparison tool.

How do I open a savings account?

Opening a savings account is a relatively simple process. If you’ve found an account with a suitable interest rate, you’ll just need to get in contact with your chosen lender via a branch, phone call or hop online to begin the process. 

You may be required to provide:

  • Personal details, including identification (driver’s license, passport etc.)
  • Tax file number
  • Employment details

Can I overdraft my savings account?

A lot of savings accounts won’t let you overdraw. Some will allow this feature but you’ll need to apply first. It’s best to read the fine print and check with your lender whether this is a feature they offer. It can be a helpful addition, but as your lender can charge you a fee as well as interest for going into negative numbers, it’s best to avoid overdrafting when possible.

What is a good interest rate for a savings account?

A good rule of thumb to keep in mind with savings accounts is to look for a rate that is higher than the CPI inflation rate. This number is constantly changing, so check the Reserve Bank of Australia’s page. If you aren’t earning interest above this then the value of your money will go backwards over time.

Can you direct deposit to a savings account?

Yes. You can make one off payments or set up regular direct deposits into a savings account. This can be organised easily through online banking or by making deposits in a branch. Talk to your lender to find out the easiest way for you to set up direct deposits.