Introduction to Savings Accounts

There's a competition out there to get your money into a bank or institution - it's called an 'interest rate on deposits' and for consumers it is all good news, compared to the flip side of that coin which is paying interest rates on loans and mortgages.

We're not talking about your standard everyday bank accounts here (standard accounts are usually called transaction accounts where money comes in and out frequently), we're talking about 'high interest savings accounts' which are specialised accounts for keeping a stable and growing account balance with the bank.

Post GFC, we've got a highly competitive market where banks are trying to win your deposits. The interest rates that they offer to depositors reflects this competition and this is great for depositors who used to be stuck with term deposits or bonds. Each savings account differs in some way so they are like any financial product where the research and comparison you do before signing up will help you make a happy buying decision.

The two major vehicles for earning high interest rates from a bank are Online / High Interest Savings Accounts and Term Deposits. Your decision on which product to use will be based on your requirement for flexibility and security. A term deposit will require you to lock in your money  for a period of time to earn a fixed rate of interest, however the interest payments do not compound with a term deposit. A high interest savings account does not commit you to a fixed term, however you will usually need to meet some criteria to earn the highest tier interest rate, like minimum balance amounts and / or a minimum monthly deposit. 

Let's look at both types of products in detail:

Savings Accounts - High Interest Savings Account

The online / high interest savings accounts are one of the few areas where banks have genuinely passed on the benefits of their branch reduction strategy and lower cost structures online to give depositors a change to earn high interest rates by self managing their accounts online / over the phone. These accounts are relatively new and were not readily available ten or so years ago when you relied on your local bank branch for everything. Many of the accounts are marketed as 'online savers' which are designed for online self management by the depositor. 

The self management is key and the bank wants you to set up the account yourself and manage it online or over the phone with no / little branch access and lower costs for the bank / provider. You can transfer money from these accounts bank to your daily transaction accounts for use in your day to day business. Setting up a new account is pretty easy and you'll need to transfer some funds into this new account, and you'll need to meet some minimum requirements on a monthly basis to achieve the highest tier of interest on many accounts. 

You don't need to have a high interest savings account with the same bank as your current transaction account or loan account and it pays to shop around. One of the most popular online savings accounts in Australia is with ING Direct where thousands of Australians flocked from their regular banks to ING's online only savings accounts.

Many of the new high interest savings accounts offer a very attractive advertised interest range, but these rates are often made up of two parts - a standard rate and a bonus rate. Interest is typically calculated daily and credited monthly for an online savings account. Some things to consider include:

• Interest Calculations: The interest calculation on savings accounts is an APR (Annual Percentage Rate) which means that the published interest rate of say 6% p.a. is calculated into a daily amount (6% / 365 days) and then calculated daily on the balance that you have in your account. The interest is usually paid into your account on a monthly basis and then this interest can compound for the following months.
• Minimum Balance: Most online savings accounts require you to have a minimum balance in the account to qualify for bonus rates on a monthly basis.
• Bonus / Introductory / Promotional Rates: Many banks offer two interest rates on their savings accounts, with an everyday standard rate, and a bonus rate based on meeting a minimum balance and minimum monthly payment requirement. Some banks have a low standard rate that is improved only with the bonus rate so make sure that you can meet the requirements or you won't get the rate that attracted you to the account.
• Minimum Deposits: Many online savings accounts require a minimum monthly deposit (e.g. $50 per month) to qualify for bonus rates.
• Withdrawal Penalties: Some accounts have withdrawal penalties if you make too many withdrawals in a given month.

Term Deposits - A Fixed Interest Rate and Fixed Term of Deposit

A term deposit is a fixed interest account where the depositor / investor gets certainty over the rate of return for their cash investment as they fix the rate of interest and fix the term of the investment. The interest rates are published as APRs which means that the rate is an annual amount. A term deposit of 6 months for $100,000 at a 6% interest rate will earn $6,000 in interest as most term deposits don't compound interest as they pay the fixed interest amount at maturity. 

Term deposits last for as little as 7 days and some even go to 7-10 years, with most capping out at 5 years. The larger the deposit and the longer the length of time, the better the return for the depositor, depending on the sentiment of the market and the outlook for the economy in general. Commonly, with a large amount of your money locked up for a long time in a term deposit, the bank / institution can then re-lend it to others at a higher margin for a longer period, hence they'll offer you higher rates for larger amounts and longer time frames.

If you've got a lot of money to deposit (close to half a million dollars and above) you should be able to negotiate a better rate than the advertised rate. If you are looking at time frames of shorter than one year, you'll usually need to wait unitl to the end of the term to be paid your interest amounts for the term deposit i.e. a 6 month term deposit will pay you at the end of the term. This is called payment at maturity. If you are looking for a longer time frame than one year, your term deposit may offer the option of receiving your interest as a monthly, quarterly, semi-annual or yearly payment, or at maturity.

Importantly, some term deposits specify that this interest will not be re-invested into the term deposit and will be deposited into another account that you set up and nominate for payments.

Here's what you should be thinking about:

• Interest Calculations: The interest calculation on term deposits is usually not compound interest and is what is called simple interest. With simple interest, you will receive a fixed amount of interest for the deposit amount and the interest earned is then paid out separately which means that you won't get earn interest on your interest amount (interest on interest is called compound interest and is a feature of high interest savings accounts).
• Don't Withdraw / End Early: With a term deposit you lock into a term so interest rate penalties may apply if you need to withdraw your funds before the end of the term. This penalty will usually be in the form of a lower rate than the rate than you signed up with to reflect the shorter term or a withdrawal fee.
• Length of Term: The length of the term is important when comparing term deposits as by their very nature, you are locking into a fixed period. We all know that cancelling anything in life, especially financial cancellations, will cost you money. Therefore you need to think about how much money you have available for a fixed term product and how long you can afford to lock it away.
• Rolling Over: If you don’t opt to take your money out of the term deposit account, it is likely that your money will be reinvested for a second similar term at the new interest rates at that time.