What It Is:
A savings account is a low-risk, interest-bearing deposit with a bank or other financial institution.
How It Works/Example:
Technically, savings accounts are time deposits, meaning that a bank can require the account holder to give notice before withdrawing the funds or impose a penalty for withdrawal before a specified date. Banks do not generally exercise this right, but institutions restrict the number of transactions allowed in and out of a savings account per month. Also, they may charge fees that vary with the average balance in the account. Institutions do not usually provide checks for savings accounts.
The interest rates on savings accounts vary by institution but are generally lower than interest rates on longer-term deposits, such as CDs or money market accounts. Interest is usually compounded monthly.
It is important to note that the interest rate paid on a savings account may be below the inflation rate, meaning that the account actually might lose purchasing power over time despite the interest earned.
Aside from the traditional savings account described here, the United States and other countries allow certain people to open special savings accounts, such as Health Savings Accounts or Coverdell Education Savings Accounts. Investors use these unique savings accounts to pay for specific items and they have special rules and tax implications.
Why It Matters:
Savings accounts are conservative, low-risk investments because the Federal Depository Insurance Corporation typically insures the accounts (up to a limit) and account owners can access their funds easily. For these reasons, the interest rate on savings accounts tends to be lower than riskier or longer-term investments such as CDs, mutual funds, or corporate bonds.