We all know saving is important. We also know to put our savings in a savings account. But do we know what savings account to choose? Not so much. No worries though, as long as you know the basics of banking, you’ll be able to understand how savings accounts work, how your money can benefit from being placed in one, and other important details, like whether you can use it for your spendings.
Before we fully dive into the topic, we should clarify one thing: A savings account is different from a chequing account. In general, a savings account will pay a higher interest rate than a chequing account (more on this later), grounded in the idea that you’re less likely to withdraw the money in your savings account, and so your bank will reward you with a higher earning interest rate.
Regardless of this idea, it is possible to make purchases from a savings account but it will depend on each bank’s rules. Many banks will limit how many transactions you can make with a savings account to still qualify for the high earning interest.
Why do we have savings accounts?
Banks are in the business of taking deposits from customers and then lending those deposits to other customers who are looking for loans. The bank charges an interest rate on that loan, then gives some of that interest to their customers.
But for a bank to be able to lend money, there must be a high volume of money in their accounts for an extended period of time. It can’t rely on chequing accounts because customers use them too frequently and the money is always moving. The solution? Savings accounts.
They’re a win-win-win for everyone involved. Savers get a higher return on their money than they would keeping it in a chequing account. The bank can trust the money deposited in savings accounts to be stable and consistent. Finally, the borrower can access the loan they need to make purchases like a home or to start a business.
While this brief explanation doesn’t encapsulate all bank processes, it does show us why savings accounts earn more interest.
Types of savings accounts
In Canada, there are a lot of options when it comes to savings accounts with varying rewards and interest rates on savings based on the business model and goals of each bank. The options, prices, and rates change frequently, but there are some main structures.
Highest interest savings accounts (HISA)
The savings accounts that offer the highest interest rates are often the most restrictive with money withdrawal. Typically, they’ll cap it at one to six withdrawals per month. If you go past this threshold, you might violate the terms of the account and lose the high interest rate or pay a charge.
Banks will make these accounts super exclusive and may even charge a monthly fee. While not common, they may also offer even higher interest rates if you consider depositing more money. For example, they may increase the interest rate after your first deposit of $100,000. This is called a tiered interest rate structure. Many banks have different rules on each type of savings account so be sure to understand all of the details before putting money into the account.
Low Interest Savings Accounts
The lowest-earning savings accounts are the ones that make it the easiest to use the money for daily purchases. They have debit cards, bill payment options, and few limits on pulling money from the account. These accounts pay the least amount of interest to savers, but they do still allow a customer to separate accounts for savings goals. Many accounts will come with a monthly or yearly fee, yet they may also offer cash back options on purchases. For people that are looking at starting to save, but do not have a lot of income, these accounts can be a good place to start.
A general rule
With so many banks offering different types of savings accounts, each equipped with various rules, it can get overwhelming. So, a good quick rule to remember is this: the easier it is to withdraw money, the less the bank is likely to pay in interest.
Some savings accounts are so flexible with withdrawals that they work almost identically to chequing accounts. These accounts will work well for those people who are saving but might need the funds for emergencies or pressing opportunities; a great play since savings accounts are a handy budgeting tool. Some economists even refer to savings accounts as "mental accounts" for savers because you’re less likely to use this pool of money over that in a chequing account. There are several easy tricks to help you save more money, but one of the best is to have a savings account so that you are not tempted to dip into the fund.
Current low interest rate environment
While most of this article has explained why savings accounts pay more interest, we’re currently experiencing historically low interest rates in Canada. There are many reasons for the low interest rates ranging from the COVID pandemic to ample government lending programs that have made borrowing easier for most people. Consequently, there is less need for banks to have more savers.
This makes saving and earning interest on that savings relatively difficult. Because of the low interest rates of even the best savings accounts, many have decided not to save but rather invest in stock markets to try and earn more on savings. While the possible return on savings could be better in markets, investing or trading securities carries risks, and those risks can be much greater than putting money in a savings account. For starters, there is no guarantee that the money invested in securities will grow in value; stocks are volatile and subject to both gains and losses.
With KOHO, you get to earn interest on every penny in your entire account, from your spendables to your savings!
Taking risk into consideration
In comparison to securities, money saved in a savings account is unlikely to be at risk from loss. In fact, a main feature of bank accounts is that most deposits are insured by the Canadian Deposit Insurance Corporation (CDIC) for up to $100,000. Most banks are members of the CDIC, but make sure to check when opening any type of bank account.
It is important to note that the CDIC does not insure against losses due to fraud or theft, mutual funds, or stocks. But it does protect the saver if the bank faces problems or has to shut down. While this is increasingly rare, throughout most of history, runs on banks were common when it was feared that the bank did not have the ability to pay deposits with enough cash. Fortunately, modern insurance and a network of government systems have eliminated the problems of bank runs.
The importance of saving
It is important to mention that savings is a way to protect against the uncertainty of the future. Savings gives the user more options throughout life. Debt, on the other hand, reduces options for a person moving through life. To illustrate the point, debt is a prediction that you will be able to repay a loan. To predict that the loan will be repaid, a borrower has to make assumptions about income several years, and sometimes decades into the future. But few things ever go according to plan, and that is what makes borrowing such a problem for both people, and societies.
Savings creates what is called optionality. Simply having money in the bank waiting to be used gives a person more options. A business opportunity, a home purchase, or the chance to raise a family, are all much easier to achieve if there is money saved and ready to be used. So while interest rates are low now, they will not always be that way. Plus, saving to increase your options in the future will never go out of fashion.
The bottom line? Using savings to make daily purchases will cost you in interest. The best way to save is to make sure that you only place money in high-interest savings accounts when you know you won’t need the money soon so your savings has the opportunity to grow and will be there when you need it.
*Interest rates are per year, calculated daily, paid monthly, and can change at any time without notice.
