Savings form a crucial part of anyone’s financial future and financial security. People with planned short-term and long-term savings are better prepared to handle financial emergencies and other financial requirements than those without. While short-term financial goals like vacations, gifts, and insurance, can be taken care of using short-term savings accounts, longer-term financial goals can be handled better using long-term savings accounts.
Long-term savings accounts are the type of savings accounts used to save money for long-term financial goals. The money saved in long-term savings accounts is usually used for buying a home, children’s education, retirement, or similar one-time, long-term expenses. It helps people make the most of their money by saving it for a more extended period, at a better rate of interest supplemented by the power of compounding.
Types of long-term savings accounts
There are many different types of long-term savings accounts that offer a variety of advantages. While some ensure high returns and yield, others are better at providing tax benefits. You can choose the long-term savings account that works the best for you based on the fees you pay, the interest you earn, tax benefits, and withdrawal rules.
High-yield savings accounts
High-yield savings accounts are long-term savings accounts that pay higher than normal interest rates. They are usually FDIC-insured and pay out higher interests as the withdrawal from this limited and require higher initial deposits. Thus, the bank or credit union compensates for the higher deposit and limited withdrawal by providing a higher annual percentage yield than standard savings accounts.
Certificates of deposit
Certificates of deposits (CDs) are another type of FDIC-insured long-term savings accounts offered by banks and credit unions. They also pay a higher interest rate; however, they differ from high-yield savings accounts in being timed accounts. The money saved in CDs is locked in for a minimum period, and withdrawals before maturity attract a penalty. The terms of certificates of deposits range between 30 days and 10 years, with a higher interest rate for longer time periods.
Education savings accounts
Many financial institutions offer specific long-term savings accounts for the purpose of children’s education. These savings accounts allow tax-free contributions for years, with tax-free withdrawals at the time when higher education commences. The interest rate is high, and withdrawal is restricted in most education savings accounts.
Individual and employer-sponsored retirement accounts
Retirement accounts are an excellent example of long-term savings accounts. They help you save for retirement and let you use the power of compounding interest to grow your money for a comfortable life post-retirement. The contributions made towards retirement accounts attract tax benefits, and the money is invested in mutual funds and ETFs to grow. Some long-term retirement savings accounts also have the potential to get matching employer contributions. Thus, you may also get free money in addition to tax savings and growth.
How a long-term savings account works
Long-term savings accounts have unique features and characteristics that can make them a better option than traditional savings accounts. The most striking feature of long-term savings accounts is the power of compounding interest. The interest earned from long-term savings accounts is, in turn, reinvested and added to the base for calculating interest for the later years.
So, in theory, the base amount for calculating the interest keeps growing with time, and the money multiplies faster, generating higher returns over time. The magic of compounding interest works exceptionally well if you start saving early in long-term savings accounts. The longer you let the money grow in these accounts, the more the interest compounds.
Additionally, the time horizon of long-term savings accounts ensures that savers do not get hassled by short-term price fluctuations and market volatility. The focus shifts from daily movements to the basic fundamentals of the investment, and can result in meaningful wealth creation over a long period. The associated risk also gets substantially minimised due to the longer time horizon as the short-term price fluctuations get balanced out by the end of the investing period.
Importance of long-term savings accounts
Long-term savings accounts give your savings a long-term perspective and help you prepare for financial needs in the future. The savings in long-term accounts come in handy for one-time lump-sum money needs, like buying a home or children’s education, and also form an integral part of funding retirement.
As we’ve touched on, the most significant advantage of long-term savings accounts is the power of compounding. They also encourage savers to stay invested during the ups and downs of the market. Investors can increase their holding power, sail through market fluctuations, and grow their money in the long-term despite short-term downward movements in market prices. The value of investments or savings in long-term savings accounts may go down temporarily; however, the magic of compounding interest and long-term horizon facilitate a net positive performance by the time of withdrawal.
Best long-term savings accounts
Thus, long-term savings accounts play a critical role in creating financial security and keeping one prepared for future financial needs. They offer higher rates of interest than traditional savings accounts due to the longer lock-in period and help the investors tide over short-term market changes.
However, the various long-term savings accounts offered by different banks and credit unions differ in their interest rates, risks, returns, and diversification. Therefore, it is essential to choose the long-term savings account that best suits your needs. The following factors must be considered when choosing the best long-term savings account for you.
Interest rate: The primary reason for investing in long-term savings accounts is higher than normal returns and interest rates. So, you should compare the interest rates offered by different financial institutions to find your best option. Most of the time, the interest rates are higher for a longer lock-in period; therefore, you should choose the most optimum combination of interest rate and withdrawal restrictions based on your time horizon and financial goals. It is also critical to ensure that the interest rates offered on the long-term savings accounts are high enough to beat inflation in the long-term.
Diversification: The risks and returns associated with long-term savings accounts are also correlated with the diversification of the investment portfolio. So, you must choose a long-term savings account with diversified investments to reduce the risks and increase the returns.
If managed well, long-term savings accounts create a disciplined portfolio to meet long-term financial needs. They make the best use of compounding interest and grow savings over the long run in a relatively steady fashion. Additionally, they inculcate the habit of investing, grow faster than traditional savings accounts, and help tide over the panic and overreaction associated with short-term price fluctuations.