Savings accounts are a dime-a-dozen. Almost every bank offers them, and you can’t turn your head without seeing one while walking down the street. However, using them and choosing which one is the best fit isn’t as clear-cut as it might seem. We break down when people living abroad should use a savings account, and what they need to look for.
In short, banks need people to leave their money with them so that they can lend and invest it. To entice people to do so, banks offer consumers different savings accounts that pay interest.
There are generally three types of savings accounts:
- Regular savings accounts: the ones that you store money in for brief periods outside of your checking/current account;
- “Premium” savings accounts: savings accounts that pay a bit higher interest in exchange for leaving money in longer;
- Time/Term deposit accounts: an account that pays a higher level of interest than the previous two but requires you to keep your money there for a fixed amount of time.
When should I use a savings account?
Savings accounts broadly serve two purposes:
- to act as a ‘firewall’ between our daily spending account and our excess cash
- to provide a risk-free space to grow our money over the short term.
The first point is clear: we always want to have cash in reserve for emergencies. This money should be readily available. As a rule of thumb, most financial advisers recommend stashing away three to six months’ worth of living expenses in a savings account.
The second usage is a bit more complicated.
A balanced investing strategy means strategically placing your money to reach various goals. The distance to the target determines the type of investment to use.
For longer-term goals, investors can take more risks since there is ample time to recover from economic slowdowns.
For shorter-term goals, risky investments like stocks or bonds could quickly wipe away the value of the account.
Since no one likes losing money, savings accounts offer a risk-free way to park cash.
Therefore savings and deposit accounts are ideal for:
- Retaining an easily-accessible rainy-day fund
- Saving for a short term goal, such as:
- An upcoming vacation
- Purchasing a property or vehicle within the next five years
- A career break or sabbatical close on the horizon
What to look for in a savings account
When you’re out shopping for a savings account, you should check four main criteria:
- The interest rate
- When you get paid the interest
- The terms such as withdrawal conditions
- The bank’s legal location
The interest rate is straight-forward. It’s the rate you’ll get paid for your deposit.
What’s more important is how often you get paid the interest. Banks will publish the annual interest rate for each account. In other words, it’s the amount you would earn over one year.
If the bank only pays interest once a year, it means that you have to wait a whole year before seeing any benefit. Since banks change that rate often, it can adversely impact your deposit.
If a bank pays the interest more frequently, then your money will grow faster.
Different interest payment periods in practice
Let’s look at a quick example.
Let’s say that you have 5,000 EUR to deposit into a savings account.
Two banks are offering 0.50% annual interest on a savings account. At the end of one year, you will earn 25.00 EUR in interest.
Bank A pays the interest once a year.
Bank B pays interest every two weeks.
Imagine that you needed to withdraw the cash six months after depositing it as you had an unexpected expense.
With bank B, you will have 5,012.50 EUR in your account. While not a lot, 12.50 EUR will at least buy you lunch.
If your money is in bank A, you will only have the initial 5,000 EUR available, since the bank only pays it annually.
Therefore, if you need to park cash for at least a year, then bank A would be the better choice. If money is going in and out on a somewhat regular basis, bank B would be more attractive for you.
Term and time deposits
Term/time deposits require savers to keep their money in that account until reaching the term. If you need your cash sooner (say, for an emergency), the bank could either charge you a fee or only return your initial amount, less any interest.
Finally, the bank’s legal location also impacts your savings. Many governments in the world guarantee savings account deposits if the bank fails. That said, some jurisdictions don’t have these protections. For savers in these countries, bank failure means a total loss of capital. Make sure that the account you open is in a country with these safeguards.
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Which account should I use?
As we mentioned, there are three different savings accounts: regular, premium, and time/term deposits.
The first two almost always allow you to take your money out free of charge. Time/term deposits are a bit different.
As mentioned, these accounts require that you leave your money for a set amount of time. In exchange, you receive a better interest rate than regular savings accounts. However, if you need your cash before the time’s up, you will either pay a fee or get your money back without interest.
If you have a known short-term future expense and you have enough in your emergency fund, then a time/term deposit is the best choice.
Otherwise, it’s generally better to stick to regular and premium savings accounts.
Putting it all together
Savings accounts play a vital role in our daily financial lives. This importance is real for everyone, regardless of whether you live abroad or 15 minutes from where you were born.
It used to be that we would receive a respectable interest rate on our savings accounts. Sadly, the days of 5% to 6% rates are long behind us. These days, we’re lucky to get 0.50%. As such, prudent investors need to know the best ways to put their money to work for them.
Getting there requires honest reflection and a sound understanding of your financial profile. Doing so isn’t always easy, and that’s why many people turn to professional financial advisers for help.
One easy thing, though, is knowing that our money should always work for us. Choosing the right savings account is a great start.
Abroaden is a company for expats, digital nomads and other world citizens looking for low-cost and transparent financial advice and investment management.
Note that this article is for information and educational purposes only. It does not constitute financial advice.