A friend recently asked me some pretty basic banking questions. Part of me was surprised, but I realized that a lot of people don’t know much about banks. Mostly she wanted to know what to do with some money she saved. But she also worried about not losing any money in the process.
Most people worry about that. You want your money to grow safely (more on FDIC insurance below), and yet many banks pay almost nothing to hold on to your funds. Meanwhile, they get to make lots of money for themselves on your money. So how can you make better-informed decisions?
Banking questions & answers
As I see it, the best thing you can do is be informed. So here are some answers to basic banking questions I’ve been asked over the years to help you research and find your best options. Hope the answers help!
What is a bank CD?
A bank CD is a type of investment that allows you to earn a set amount of interest for a specific amount of time. For instance, you may decide to invest $1,000 for 3 years at 2.5%. Not only would you be earning interest on the original amount, but you would be “compounding” the interest.
In effect, that means you earn interest on the interest as well as on the original amount over time. And for the example above, you’d wind up with $1,076.89 at the end of the three years.
Just make sure you pay attention to the annual percentage yield (APY), which is not always the same as the stated interest rate. APY tells the real story, including compounding.
For more of those banking questions:
Why do banks pay so little for savings?
This is one of the most frequently-asked banking questions. The simplest answer is because they can get away with it. They’re looking to create the biggest “spread” between what they pay for money and how much they earn from that same money.
And because bank savings accounts are considered safe, people figure better safe than sorry. Even if investors can earn more somewhere else, they could also lose money — as with stocks, bonds, and funds.
How do banks make money?
As I mentioned above, banks look to pay as little as possible for a (hopefully endless) supply of new money so that they can use those dollars (or euros or yen) to make more money.
Let’s say you give them $1,000 and they only pay you .01% per year. (Some banks pay that or less.) Over the course of a year, you will have made 10 cents. That’s right … 10 CENTS. And let’s also say they loaned that same money to someone for 5% — or $50 over a year.
So their profit is $49.90. Imagine doing that with billions of dollars. The less they pay you, the more they make. And, lucky for them, many of us keep money in accounts that pay close to zero. Not a bad business, huh?
Are my bank account savings safe?
First, you want to make sure you are dealing with a legitimate bank. The FDIC (Federal Depoisit Insurance Corporation) has a site that explains how to check this.
As for the safety of your money, in the event of a bank failure of some kind, you’re covered by the FDIC up to $250,000 for EACH bank account. I’d use FDIC Bankfind to check on this, just in case.
If you are lucky enough to have more than $250,000, make sure you don’t put all of it in one account. Still, to confirm you’re doing it right, this is one of those banking questions you need to ask your bank!
Why keep money in a bank if stocks can make more?
The complete answer to that is not so simple. But the quick answer is it’s safer. Over many years, stocks have historically done better than a bank account. But at any given time, in a bank account you’ll know exactly how much your money is worth.
NOTE: We are talking mainly about things like checking, savings, or CDs — also known as “deposit accounts.” But banks now also offer bank Money Market Accounts. For more on that, see below.
What is a bank?
In simplest terms, banks are financial institutions that take investor deposits and make money. They are legally created to accept and safeguard deposits and to make loans. Or in other ways invest their money to the benefit of customers as well as shareholders / governing agencies.
As an essential part of the economy, they are part of the ripple effect of money, such as when your deposited money lets a business borrow to help make more money and create jobs. And, hopefully, your deposited money also makes you some money — in the form of interest.
Difference between a bank and a brokerage firm?
In theory, although some might argue this point, banks serve the public good in addition to taking and making money. There may be local business investment benefits and, in many cases, special lending programs designed to add to community development as a whole.
Brokerage firms exist to make money. They may have charity foundations and contribute to the public good in some way by choice, but their main goal is to help people / organizations buy and sell securities. And they make money whether you win or lose.
Once again, while banks offer FDIC insurance, brokerage firms do not. You buy and sell stocks, bonds, funds or other financial investments at your own risk. Although more and more, they do offer bank-like products (such as brokered CDs) with some assurance of protection.
When dealing with brokerage companies, make sure you look out for fees and other costs of doing business. They are NOT all the same. Discounted brokerage firms that provide some research and advice may be a a good bet even for new investors.
Bank vs brokerage money market funds
In order to offer a more attractive savings option, many banks created money market savings accounts (MMAs) that pay a little more than checking or savings. Although not as much as CDs, which require you keep all the money there for a set amount of time. You need to check the rules for how many withdrawals, checks, etc. your bank allows for MMAs.
As for brokerage money market funds, they are similar to stock or bond funds. But they are invested in high-grade government short-term debt securities, such as US Treasury bills. These are investments and not bank deposits, so they are not insured by the FDIC. Although some may be covered by protection of some sort, so check with your broker.
Are online banks safe?
I admit that at first I was hesitant to try an online ONLY bank. But, after a good deal of research, I wound up opening an online account and am very happy with my experience so far. Although sometimes customer service wait times can be long.
Once again, you want to check to see if the bank is legitimate and FDIC insured. You’ll need to ask your own banking questions about existing options and do your own research to find an online bank you like. And it may not just be about rate. What works for me may not be the right choice for you.
This post explains more about online banking:
How much should I keep in checking account?
I included this question since a lot of money is lost by checks that bounce. Overdraft accounts can help avoid the bounce fees, but you still will be charged for the amount “borrowed.”
Although I know that many times it’s hard to cover even the most necessary expenses, keeping enough in your checking account to cover your monthly expenses will go a long way to helping you protect your money in the long run.
Some tips to help manage and budget for expenses:
Why do banks charge fees for everything?
Once again, the answer is because they can. I think it’s horrible the way banking customers are nickeled and dimed out of their precious savings. They work hard for that money, and the very people who can’t afford to keep huge balances are the ones who get penalized.
The best thing you can do is look for banks (or credit unions) with low fees or no fees. Some banks will give you a break if you can keep a certain amount in the bank at all times. Ideally you want the bank with the lowest requirement to get that benefit.
Other than that, your best plan is to minimize how many times you withdraw money or do other things that cost you. With just a bit of careful personal financial management, you can help banks take less of YOUR hard-earned money.
What should I know about bank loans?
Well, there’s a lot to lending. I was actually trained in bank lending right out of grad school. But the two most important things I learned were:
- It’s important to get a feeling that you can trust the person.
- You need to make sure the odds of getting paid back are VERY good.
If you want to borrow money from a bank, make sure you can show you are trustworthy and can / will pay it back. Bringing along your cash flow and budget statements (see above) might help you prove your case — and add a plus to the “has thought this through carefully” column.
Also, make sure you really need the money. A loan costs you money (the interest you pay) and squeezes your monthly expenses until it is paid off. If there is any other way, such as taking some extra work for a while, see if you can go that route instead. Loans affect your credit, and that can also cost you even more money.
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