A Starter Savings Account

By: Gary Foreman

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%.


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. You'll find hundreds of free articles to stretch your day and your budget.

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