Bank checking accounts and debit cards

Whether it’s paying monthly bills or having something in your wallet to make purchases with at restaurants and retail stores, we all need the ability to conduct transactions and access our money. I’m not a fan of credit cards, because the credit feature enables you to spend money you don’t have and carry a debt balance month to month. Notwithstanding the lower short-term interest rates some cards charge to lure new customers, the reality is that borrowing on credit cards is expensive — usually, to the tune of more than 18 percent.

Paying a credit card bill in full each month is the smart way to use such a card and avoid these high interest charges. But about half of all credit card holders use the high-interest-rate credit feature on their cards.

Debit cards are excellent transaction vehicles and a better alternative for folks who are prone to borrow via their credit cards. A debit card connects to your checking account, thus eliminating the need for you to carry around excess cash. And as with a credit card, you can dispute transactions if the product or service isn’t what the seller claimed it would be and fails to stand behind it. But unlike a credit card, a debit card has no credit feature, so you can’t spend money you don’t have. (Some checking accounts offer prearranged lines of credit for overdrafts.)

During periods of low interest rates, the fees levied on a transaction account, like a checking account, should be of greater concern to you than the interest paid on account balances. After all, you shouldn’t be keeping lots of extra cash in a checking account; you’ve got better options for that, which I discuss in the rest of this chapter.

One reason why bank customers have gotten lousy terms on their accounts is that they gravitate toward larger banks and their extensive ATM networks so that they can easily get cash when they need it. These ATM networks (and the often-associated bank branches) are costly for banks to maintain. So you pay higher fees and get lower yields when you’re the customer of a bank with a large ATM network, especially a bank that does tons of advertising.

By using a debit card that carries a VISA or MasterCard logo, you won’t need to access and carry around much cash. Debit cards are widely accepted by merchants and are connected to your checking account. These cards can be used for purchases and for obtaining cash from your checking account.

Savings accounts and certificates of deposit

Banks generally pay higher interest rates on savings account balances than they do on checking account balances. But they have often lagged behind the best money market funds, offered by mutual fund companies and brokerage firms (see Chapter 7). Online banking is changing that dynamic, however, and now the best banks offer competitive rates on savings accounts.

The virtue of most savings accounts is that you can earn some interest yet have penalty-free access to your money. The investment won’t fluctuate in value the way that a bond will, and you don’t have early-withdrawal penalties, as you do with a certificate of deposit (CD).

The yield on bank savings accounts is generally pretty crummy. That’s why your friendly neighborhood banker will be quick to suggest a CD as a higher-yielding investment alternative to a bank savings account. He or she may tout the fact that unlike a bond (discussed in Chapter 9), a CD doesn’t have fluctuating principal value. CDs also give you the peace of mind afforded by the government’s FDIC insurance program.

CDs pay higher interest rates than savings accounts because you commit to tie up your money for a period of time, such as 6 or 12 months, or 3 or 5 years. The bank pays you, say, 2 percent and then turns around and lends your money to others through credit cards, auto loans, and so on. The bank charges those borrowers an interest rate of 10 percent or more. Not a bad business!

I’m not a fan of CDs. I’ve found that investors often use CDs by default without researching their pros and cons. Here are some drawbacks that your banker may neglect to mention:

• Early-withdrawal penalties: When you tie up your money in a CD and later decide that you want it back before the CD matures, a hefty penalty (typically, about six months’ interest) is usually shaved from your return. With other lending investments, such as bonds and bond mutual funds, you can access your money without penalty and generally at little or no cost.
• Mediocre yields: In addition to carrying penalties for early withdrawal, a CD yields less than a high-quality bond with a comparable maturity (such as two, five, or ten years). Often, the yield difference is 1 percent or more, especially if you don’t shop around and simply buy CDs from the local bank where you keep your checking account.
• Only one tax flavor: High-tax-bracket investors who purchase CDs outside their retirement accounts should be aware of a final and perhaps fatal flaw of CDs: The interest on CDs is fully taxable at the federal and state levels. Bonds, by contrast, are available in tax-free (federal and/or state) versions, if you desire.

You can earn higher returns and have better access to your money when it’s in bonds than you can when it’s in CDs. Bonds make especially good sense when you’re in a higher tax bracket and would benefit from tax-free income in a nonretirement account. CDs may make sense when you know, for example, that you can invest your money for, say, two years, after which time you need the money for some purchase that you expect to make. Just make sure that you shop around to get the best interest rate from an FDIC-insured bank. If having that U.S. government insurance gives you peace of mind, consider investing in Treasury bonds, which tend to pay more interest than many CDs (see Chapter 9).

Evaluating any bank

Most folks know to look for a bank that participates in the U.S.-government-operated FDIC program. Otherwise, if the bank fails, your money on deposit isn’t protected. FDIC covers your deposits up to a cool $250,000.

Some online banks are able to offer higher interest rates because they are based overseas and, therefore, are not participating in the FDIC program. (Banks must pay insurance premiums into the FDIC fund, which adds, of course, to a bank’s costs.) Another risk for you is that noncovered banks may take excessive risks with their business to be able to pay depositors higher interest rates.

When considering doing business with an online bank or a smaller bank you’ve not heard of, you should be especially careful to ensure that the bank is covered under FDIC. Don’t simply accept the bank’s word for it or the display of the FDIC logo in its offices or on its website.

Check the FDIC’s website database of FDIC-insured institutions to see whether the bank you’re considering doing business with is covered. Search by going to the FDIC’s Bank Find page (www2.fdic.gov/idasp/main.asp). You can search by the name, city, state, or zip code of the bank. For insured banks, you can see the date when it became insured, its insurance certificate number, the main office location for the bank (and branches), its primary government regulator, and other links to detailed information about the bank. In the event that your bank doesn’t appear on the FDIC list, yet the bank claims FDIC coverage, contact the FDIC at (877) 275-3342.

In addition to ensuring that a bank is covered by FDIC, investigate the following:

• What is the bank’s reputation for its services? This may not be easy to discern, but at a minimum, you should conduct an Internet search of the bank’s name along with the words complaints or problems and examine the results.
• How accessible are customer-service people at the bank? Is a phone number provided on the bank’s website? How hard is it to reach a live person? Are the customer-service representatives you reach knowledgeable and service-oriented?
• What are the process and options for getting your money out? This issue is a good one to discuss with the bank’s customer-service people.
• What fees are charged for particular services? This information should be posted on the bank’s website in a section called something like Accounts Terms or Disclosures. Also, request and inspect the bank’s Truth in Savings Disclosure, which answers relevant account questions in a standardized format. Figure 6-1 is an example of an online bank’s disclosure for savings accounts.

Protecting yourself when banking online

The attractions of banking online are pretty obvious. For starters, it can be enormously convenient, as you bank when you want on your computer. You don’t have to race around during your lunch break to find a local bank branch. And thanks to their lower overhead, the best online banks are able to offer competitive interest rates and account terms to their customers.

You probably know from experience that conducting any type of transaction online is safe as long as you use some common sense and know who you’re doing business with before you go forward. That said, others who’ve gone before you have gotten ripped off, and you do need to protect yourself.

Take the following steps to protect yourself and your identity when conducting business online:

• Never access your bank accounts from a shared computer or on a shared network, such as the free access networks offered in hotel rooms and in other public or business facilities.
• Make certain that your computer has antivirus and firewall software that is updated periodically to keep up with the latest threats.
• Be aware of missed statements, which could indicate that your account has been taken over.
• Report unauthorized transactions to your bank or credit card company as soon as possible; otherwise, your bank may not stand behind the loss of funds.
• Use a complicated and unique password (including letters and numbers) for your online bank account.
• Log out immediately after completing your transactions on financial websites.

Credit union accounts and benefits

Credit unions are unique creatures (I guess I should say a unique species) within the financial-services-firm universe. Credit unions are similar to banks in the products and services that they offer (although private banks tend to offer a deeper array). However, unlike banks, which are run as private businesses seeking profits, credit unions operate as nonprofit entities and are technically owned by their members (customers).

The best credit unions offer their customers better terms on deposits, including checking and savings accounts (higher interest rates and lower fees) and some loans (lower rates and fees). If they’re efficiently operated, they’re able to do so because they don’t need to make a profit.

Don’t assume that credit unions necessarily or always offer better products and services than traditional banks, because they don’t. The profit motive of private businesses isn’t evil; quite to the contrary, the profit motive spurs businesses to keep getting better at and improving on what they do.

Credit unions have insurance coverage up to $250,000 per customer through the National Credit Union Administration (NCUA), similar to the FDIC protection that banks offer their customers. As when checking out a bank, be sure that any credit union you may deposit money into has NCUA insurance coverage.

The trick to getting access to a credit union is that by law, each individual credit union may offer its services only to a defined membership. Examples of the types of credit union memberships available include

• Alumni
• College and university
• Community
• Employer
• Place of worship

There can be some overlap between these groups. To access a credit union, you also may be able to use your family ties.

To find credit unions in your local area, visit the Credit Union National Association website at www.cuna.org, and click the Consumers link.

Brokerage accounts

A type of account worth checking out at brokerage firms is generally known as an asset management account. When these types of accounts first came into existence decades ago, they really were only for affluent investors. That is no longer the case, although the best deals on such accounts at some firms are available to higher-balance investors.

Brokerage firms enable you to buy and sell stocks, bonds, and other securities. Among the larger brokerage firms or investment companies with substantial brokerage operations you may have read or heard about are Charles Schwab, ETrade, Fidelity, ScottTrade, T.D. Ameritrade, and Vanguard.

Now, some of these firms have fairly extensive branch office networks, and others don’t. But those that have a reasonable number of branch offices have been able to keep a competitive position because of their extensive customer and asset base and because they aren’t burdened by banking regulations (they aren’t banks) and the costs associated with operating as a bank.

The best of brokerage firm asset management accounts typically enable you to

• Invest in various investments, such as stocks, bonds, mutual funds, and exchange-traded funds, and hold those investments in a single account.
• Write checks against a money market balance that pays competitive yields (although recently, yields have been close to zero).
• Use a VISA or MasterCard debit card for transactions.

Money market mutual funds

Because bank savings accounts historically have paid pretty crummy interest rates, you need to think long and hard about keeping your spare cash in the bank. Instead of relying on the bank, try keeping your extra savings in a money market fund, which is a type of mutual fund. (Other funds focus on bonds or stocks.) Money market funds historically have offered a higher-yielding alternative to bank savings and bank money market deposit accounts. I use a money market fund that offers unlimited check writing at a mutual fund company. I also don’t keep my extra savings in the bank.

The mutual fund business is huge; fund companies hold assets totaling in excess of $12 trillion. A significant portion of that — nearly $3 trillion — is held in money market mutual funds.

A money market fund is similar to a bank savings account except that it is offered by a mutual fund company and therefore lacks FDIC coverage. Historically, this hasn’t been a problem, as retail money market funds have never lost shareholder principal for retail investors.

The attraction of money market funds has been that the best ones pay higher yields than bank savings accounts and also come in tax-free versions, which is good for higher-tax-bracket investors. I explain money market funds in greater detail in Chapter 7.