People hold cash and other forms of liquid assets, such as checking and savings accounts, for the convenience they offer in making purchase transactions, meeting normal living expenses, and providing a safety net, or cushion, to meet unexpected expenses or take advantage of unanticipated opportunities. Financial institutions compete to offer a wide array of products meeting every liquid-asset need.
The federal Truth-in-Savings Act of 1993 helps consumers evaluate the terms and costs of banking products. Depository financial institutions must clearly disclose fees, interest rates, and terms of both checking and savings accounts. The act places strict controls on bank advertising and on what constitutes a “free” account. For example, banks cannot advertise free checking if there are minimum balance requirements or per-check charges. Banks must use a standard annual percentage yield (APY) formula that takes compounding (discussed later) into account when stating the interest paid on accounts. This makes it easier for consumers to compare each bank’s offerings. The law also requires banks to pay interest on a customer’s full daily or monthly average deposit balance. Banks are prohibited from paying interest on only the lowest daily balance and from paying no interest if the account balance falls below the minimum balance for just 1 day. In addition, banks must notify customers 30 days in advance before lowering rates on deposit accounts or certificates of deposit.
The federal Truth-in-Savings Act of 1993 helps consumers evaluate the terms and costs of banking products. Depository financial institutions must clearly disclose fees, interest rates, and terms of both checking and savings accounts. The act places strict controls on bank advertising and on what constitutes a “free” account. For example, banks cannot advertise free checking if there are minimum balance requirements or per-check charges. Banks must use a standard annual percentage yield (APY) formula that takes compounding (discussed later) into account when stating the interest paid on accounts. This makes it easier for consumers to compare each bank’s offerings. The law also requires banks to pay interest on a customer’s full daily or monthly average deposit balance. Banks are prohibited from paying interest on only the lowest daily balance and from paying no interest if the account balance falls below the minimum balance for just 1 day. In addition, banks must notify customers 30 days in advance before lowering rates on deposit accounts or certificates of deposit.
Checking Accounts
A checking account held at a financial institution is a demand deposit, meaning, that the bank must permit these funds to be withdrawn whenever the account holder demands. You put money into your checking account by depositing funds; you withdraw it by writing a check, using a debit card, or making a cash withdrawal. As long as you have sufficient funds in your account, the bank, when presented with a valid check or an electronic debit, must immediately pay the amount indicated by deducting it from your account. Money held in checking accounts is liquid, so you can easily use it to pay bills and make purchases. Regular checking is the most common type of checking account. Traditionally, it pays no interest, and any service charges can be waived if you maintain a minimum balance (usually between $500 and $1,500). Many banks are moving away from such minimum balance requirements. Technically, only commercial banks can offer noninterest- paying regular checking accounts. Savings banks, S&Ls, and credit unions also offer checking accounts; but these accounts, which must pay interest, are called NOW (negotiable order of withdrawal) accounts or, in the case of credit unions, share draft accounts. Demand deposit balances are an important type of cash balance, and using checks to pay bills or electronic debits to make purchases gives you a convenient payment record.
Savings Accounts
A savings account is another type of liquid asset available at commercial banks, S&Ls, savings banks, credit unions, and other types of financial institutions. Savings deposits are referred to as time deposits because they are expected to remain on deposit for longer periods of time than demand deposits. Because savings deposits earn higher rates of interest, savings accounts are typically preferable to checking accounts when the depositor’s goal is to accumulate money for a future expenditure or to maintain balances for meeting unexpected expenses. Most banks pay higher interest rates on larger savings account balances. For example, a bank might pay 2.00% on balances up to $2,500, 2.50% on balances between $2,500 and $10,000, and 2.75% on balances of more than $10,000.
A checking account held at a financial institution is a demand deposit, meaning, that the bank must permit these funds to be withdrawn whenever the account holder demands. You put money into your checking account by depositing funds; you withdraw it by writing a check, using a debit card, or making a cash withdrawal. As long as you have sufficient funds in your account, the bank, when presented with a valid check or an electronic debit, must immediately pay the amount indicated by deducting it from your account. Money held in checking accounts is liquid, so you can easily use it to pay bills and make purchases. Regular checking is the most common type of checking account. Traditionally, it pays no interest, and any service charges can be waived if you maintain a minimum balance (usually between $500 and $1,500). Many banks are moving away from such minimum balance requirements. Technically, only commercial banks can offer noninterest- paying regular checking accounts. Savings banks, S&Ls, and credit unions also offer checking accounts; but these accounts, which must pay interest, are called NOW (negotiable order of withdrawal) accounts or, in the case of credit unions, share draft accounts. Demand deposit balances are an important type of cash balance, and using checks to pay bills or electronic debits to make purchases gives you a convenient payment record.
Savings Accounts
A savings account is another type of liquid asset available at commercial banks, S&Ls, savings banks, credit unions, and other types of financial institutions. Savings deposits are referred to as time deposits because they are expected to remain on deposit for longer periods of time than demand deposits. Because savings deposits earn higher rates of interest, savings accounts are typically preferable to checking accounts when the depositor’s goal is to accumulate money for a future expenditure or to maintain balances for meeting unexpected expenses. Most banks pay higher interest rates on larger savings account balances. For example, a bank might pay 2.00% on balances up to $2,500, 2.50% on balances between $2,500 and $10,000, and 2.75% on balances of more than $10,000.
Although financial institutions generally have the right to require a savings account holder to wait a certain number of days before receiving payment of a withdrawal, most are willing to pay withdrawals immediately. In addition to withdrawal policies and deposit insurance, the stated interest rate and the method of calculating interest paid on savings accounts are important considerations when choosing the financial institution in which to place your savings.
Interest-Paying Checking Accounts
Depositors can choose from NOW accounts, money market deposit accounts, and money market mutual funds. NOW Accounts. Negotiable order of withdrawal (NOW) accounts are checking accounts on which the financial institution pays interest. There is no legal minimum balance for a NOW, but many institutions impose their own requirement, often between $500 and $1,000. Some pay interest on any balance in the account, but most institutions pay a higher rate of interest for balances above a specified amount.
Money Market Deposit Accounts. Money market deposit accounts (MMDAs) are a popular offering at banks and other depository institutions and compete for deposits with money market mutual funds. MMDAs are popular with savers and investors because of their convenience and safety, because deposits in MMDAs (unlike those in money funds) are federally insured. Most banks require a minimum MMDA balance of $1,000 or more.
Depositors can use check-writing privileges or ATMs to access MMDA accounts. They receive a limited number (usually six) of free monthly checks and transfers but pay a fee on additional transactions. Although this reduces the flexibility of these accounts, most depositors view MMDAs as savings rather than convenience accounts and do not consider these restrictions a serious obstacle. Moreover, MMDAs pay the highest interest rate of any bank account on which checks can be written. A major problem with the growing popularity of interest-paying checking accounts has been a rise in monthly bank charges, which can easily amount to more than the interest earned on all but the highest account balances. So the higher rates of interest offered by MMDAs can be misleading.
Money Market Mutual Funds. Money market mutual funds have become the most successful type of mutual fund ever offered. A money market mutual fund (MMMF) pools the funds of many small investors to purchase high-return, short-term marketable securities offered by the U.S. MMMFs have historically paid interest at rates of 1% to 3% above those paid on regular savings accounts. Moreover, investors have instant access to their funds through check-writing privileges, although these must be written for a stipulated minimum amount (often $500). The checks look like, and are treated like, any other check drawn on a demand deposit account. As with all interest-bearing checking accounts, you continue to earn interest on your money while the checks make their way through the banking system.
Asset Management Accounts
Perhaps the best example of a banking service offered by a nondepository financial institution is the asset management account (AMA), or central asset account. The AMA is a comprehensive deposit account that combines checking, investing, and borrowing activities and is offered primarily by brokerage houses and mutual funds. AMAs appeal to investors because they can consolidate most of their financial transactions at one institution and on one account statement.
Interest-Paying Checking Accounts
Depositors can choose from NOW accounts, money market deposit accounts, and money market mutual funds. NOW Accounts. Negotiable order of withdrawal (NOW) accounts are checking accounts on which the financial institution pays interest. There is no legal minimum balance for a NOW, but many institutions impose their own requirement, often between $500 and $1,000. Some pay interest on any balance in the account, but most institutions pay a higher rate of interest for balances above a specified amount.
Money Market Deposit Accounts. Money market deposit accounts (MMDAs) are a popular offering at banks and other depository institutions and compete for deposits with money market mutual funds. MMDAs are popular with savers and investors because of their convenience and safety, because deposits in MMDAs (unlike those in money funds) are federally insured. Most banks require a minimum MMDA balance of $1,000 or more.
Depositors can use check-writing privileges or ATMs to access MMDA accounts. They receive a limited number (usually six) of free monthly checks and transfers but pay a fee on additional transactions. Although this reduces the flexibility of these accounts, most depositors view MMDAs as savings rather than convenience accounts and do not consider these restrictions a serious obstacle. Moreover, MMDAs pay the highest interest rate of any bank account on which checks can be written. A major problem with the growing popularity of interest-paying checking accounts has been a rise in monthly bank charges, which can easily amount to more than the interest earned on all but the highest account balances. So the higher rates of interest offered by MMDAs can be misleading.
Money Market Mutual Funds. Money market mutual funds have become the most successful type of mutual fund ever offered. A money market mutual fund (MMMF) pools the funds of many small investors to purchase high-return, short-term marketable securities offered by the U.S. MMMFs have historically paid interest at rates of 1% to 3% above those paid on regular savings accounts. Moreover, investors have instant access to their funds through check-writing privileges, although these must be written for a stipulated minimum amount (often $500). The checks look like, and are treated like, any other check drawn on a demand deposit account. As with all interest-bearing checking accounts, you continue to earn interest on your money while the checks make their way through the banking system.
Asset Management Accounts
Perhaps the best example of a banking service offered by a nondepository financial institution is the asset management account (AMA), or central asset account. The AMA is a comprehensive deposit account that combines checking, investing, and borrowing activities and is offered primarily by brokerage houses and mutual funds. AMAs appeal to investors because they can consolidate most of their financial transactions at one institution and on one account statement.
A typical AMA account includes an MMDA with unlimited free checking, a Visa or MasterCard debit card, use of ATMs, and brokerage and loan accounts. Annual fees and account charges, such as a per-transaction charge for ATM withdrawals, vary; so it pays to shop around. AMAs have increased in popularity as more institutions have lowered minimum balance requirements to $5,000, and they pay higher interest rates on checking account deposits than banks do. Their distinguishing feature is that they automatically “sweep” excess balances for example, those more than $500 into a higher-return MMMF daily or weekly. When the account holder needs funds to purchase securities or cover checks written on the MMDA, the funds are transferred back to the MMDA. If the amount of securities purchased or checks presented for payment exceeds the account balance, the needed funds are supplied automatically through a loan.
Although AMAs are an attractive alternative to a traditional bank account, they have some drawbacks. Compared with banks, there are fewer “branch” locations. However, AMAs are typically affiliated with ATM networks, making it easy to withdraw funds. Yet ATM transactions are more costly; checks can take longer to clear; and some bank services, such as traveler's and certified checks, may not be offered. AMAs are not covered by deposit insurance, although these deposits are protected by the Securities Investor Protection Corporation and the firm’s private insurance.Electronic Banking
Although AMAs are an attractive alternative to a traditional bank account, they have some drawbacks. Compared with banks, there are fewer “branch” locations. However, AMAs are typically affiliated with ATM networks, making it easy to withdraw funds. Yet ATM transactions are more costly; checks can take longer to clear; and some bank services, such as traveler's and certified checks, may not be offered. AMAs are not covered by deposit insurance, although these deposits are protected by the Securities Investor Protection Corporation and the firm’s private insurance.Electronic Banking
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