Checking and savings accounts: Meaning, Criticisms & Real-World Uses

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What Is Checking and Savings Accounts?

Checking and savings accounts are fundamental types of deposit accounts offered by financial institutions, allowing individuals and businesses to securely manage their money. These accounts fall under the broader financial category of personal finance, focusing on liquidity and capital preservation. A checking account is primarily designed for frequent transactions and easy access to funds for daily expenses, while a savings account is intended for holding funds not immediately needed, often earning interest. Both checking and savings accounts play a crucial role in financial planning by providing a safe place for funds and facilitating transactions.

History and Origin

The concept of deposit banking, which underpins checking and savings accounts, has ancient roots, with early forms of money keeping and transfer emerging in various civilizations. In the United States, early checking practices date back to the 17th century when Boston businessmen used notes against a fund to write checks¹³. The modern checking account, with physical checks and checkbooks, gained prominence in the early 20th century¹². The establishment of the Federal Reserve in 1913 significantly streamlined the check clearing process, which had previously been slow and expensive¹¹. By the 1970s, checks were the most popular method of payment in the U.S., accounting for nearly 90% of all payments in 1979¹⁰.

Savings accounts also evolved alongside banking. In the early 20th century, regulations like the Federal Reserve Board's Regulation D were introduced, which historically set reserve requirements for banks and limited the number of certain transactions from savings and money market accounts to six per month. However, in April 2020, the Federal Reserve reduced reserve requirements to zero and eliminated the six-per-month transaction limit for savings accounts in response to the COVID-19 pandemic, providing greater financial flexibility⁸, ⁹.

Key Takeaways

Checking accounts offer high liquidity for daily transactions, while savings accounts are geared towards accumulating funds, often earning interest.
Deposits in both checking and savings accounts at FDIC-insured banks are protected up to $250,000 per depositor, per insured bank, per ownership category.
Inflation can erode the purchasing power of funds held in checking and savings accounts, especially if interest rates earned are lower than the inflation rate.
While convenient, keeping excessive funds in checking accounts may mean missing out on higher earning potential from other investment vehicles.

Formula and Calculation

While there isn't a complex formula for checking accounts, as they typically do not earn significant interest, the calculation for interest earned on a savings account is straightforward, using the simple interest formula:

I = P \times R \times T

Where:

(I) = Interest earned
(P) = Principal amount (initial deposit)
(R) = Annual interest rates (expressed as a decimal)
(T) = Time the money is deposited (in years)

For example, if you have a principal (P) of $1,000 in a savings account with an annual interest rate (R) of 0.5% (or 0.005) for one year (T), the interest earned would be:

I = \$1,000 \times 0.005 \times 1 = \$5

Interpreting Checking and Savings Accounts

Checking accounts are designed for transactional purposes, offering immediate access to liquid assets through methods like debit cards, checks, and digital banking platforms. Their primary value lies in convenience and facilitating payments. The interpretation of a checking account balance often revolves around managing cash flow and ensuring sufficient funds for upcoming expenses.

Savings accounts, conversely, are typically viewed as vehicles for short- to medium-term financial goals, such as an emergency fund or a down payment. The interpretation here focuses on the growth of the principal through earned interest and the extent to which the balance is keeping pace with or exceeding the rate of inflation. A higher interest rate on a savings account generally indicates a better return on your deposited funds.

Hypothetical Example

Consider an individual, Sarah, who receives her monthly salary of $3,000. She decides to allocate these funds between a checking and a savings account.

Checking Account: Sarah keeps $1,500 in her checking account to cover her monthly bills, groceries, and other recurring expenses. This ensures she has immediate access to funds for her daily spending without incurring overdraft fees. She uses her debit card for purchases and online bill pay for her rent and utilities.
Savings Account: Sarah deposits the remaining $1,500 into a high-yield savings account that offers a 3% annual interest rate. Her goal is to save for a down payment on a house, which she anticipates needing in three years. Each month, she continues to transfer a portion of her income into this savings account. After one year, assuming consistent deposits and a 3% annual interest rate, her savings account balance will grow, allowing her to build her down payment fund effectively while earning interest on her accumulated savings.

Practical Applications

Checking and savings accounts are fundamental tools in personal financial management with several practical applications:

Daily Spending and Bill Payment: Checking accounts are ideal for managing everyday expenditures, allowing for seamless payments via debit cards, online transfers, and checks.
Emergency Funds: Savings accounts are commonly used to build and hold emergency funds, providing a financial safety net for unexpected expenses like medical emergencies or job loss.
Short-Term Savings Goals: Individuals use savings accounts to accumulate funds for specific short-term goals, such as a vacation, a new appliance, or holiday shopping.
Direct Deposit: Many employers offer direct deposit, channeling paychecks directly into checking or savings accounts, providing immediate access to funds and eliminating the need for physical checks.
FDIC Insurance: Deposits in both checking and savings accounts at banks insured by the Federal Deposit Insurance Corporation (FDIC) are protected up to $250,000 per depositor, per insured bank, for each account ownership category. This federal insurance provides security and confidence in the banking system⁶, ⁷. Consumers can verify a bank's FDIC insurance status through the FDIC's BankFind tool⁵.

Limitations and Criticisms

While essential, checking and savings accounts have certain limitations:

Low Returns: A significant criticism of traditional checking and savings accounts is their typically low interest rates. In periods of high inflation, the returns earned may not keep pace with the rising cost of living, leading to a decrease in purchasing power over time⁴. As a Reuters report noted, if the inflation rate exceeds the interest earned, an investor effectively loses money in terms of real value³.
Inflation Risk: The primary risk associated with checking and savings accounts, especially for long-term savings, is inflation risk. Unless the interest rate earned outpaces inflation, the real value of the money held in these accounts diminishes.
Transaction Limits (Historical): Historically, savings accounts were subject to withdrawal limitations under Regulation D, restricting convenient transfers to six per month². While this federal requirement was suspended in 2020, some banks may still impose their own limits¹.
Opportunity Cost: Keeping large sums of money in low-interest checking and savings accounts can represent an opportunity cost, as these funds could potentially earn higher returns if invested in other financial instruments like certificates of deposit, bonds, or stocks, depending on an individual's risk tolerance.

Checking and Savings Accounts vs. Money Market Accounts

Checking accounts and savings accounts are often confused with money market accounts (MMAs), although distinct differences exist.

Feature	Checking Accounts	Savings Accounts	Money Market Accounts (MMAs)
Primary Purpose	Day-to-day transactions, bill payment	Saving for short-to-medium term goals	Saving with competitive interest and limited transactions
Liquidity/Access	High (debit cards, checks, online transfers)	Moderate (online transfers, ATM withdrawals, sometimes limited checks)	Moderate (limited check-writing, debit card access)
Interest Earned	Generally low or none	Typically low, but higher than checking	Often higher than traditional savings, but fluctuates with market rates
Transaction Limits	Generally unlimited	Historically limited by Regulation D (now suspended, but bank-specific limits may apply)	Historically limited by Regulation D (now suspended, but bank-specific limits may apply)
Minimum Balance	Varies, some require a minimum to avoid fees	Varies, some require a minimum to earn interest	Often higher than traditional savings

The key area of confusion often stems from MMAs offering check-writing privileges and debit card access, similar to checking accounts, while also earning interest like savings accounts. However, MMAs generally have stricter transaction limits and may require higher minimum balances to open or avoid fees compared to standard checking and savings accounts.

FAQs

Q: Are my funds in checking and savings accounts safe?

A: Yes, if your accounts are at a bank insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures deposits up to $250,000 per depositor, per insured bank, for each account ownership category. This protection covers both checking and savings accounts.

Q: Can I link my checking and savings accounts?

A: Yes, most financial institutions allow you to link your checking and savings accounts for easy transfers between them. This is often used for overdraft protection or for automatically transferring funds from checking to savings.

Q: Do checking accounts earn interest?

A: While some checking accounts, particularly interest-bearing checking accounts, may offer a small amount of interest, traditional checking accounts are primarily designed for transactions and generally offer little to no interest. Savings accounts are typically where you earn interest on your deposited funds.

Q: How can I access money from my checking or savings account?

A: You can access funds from your checking account using a debit card, writing checks, online transfers, or withdrawing cash at a bank branch or automated teller machine. For savings accounts, access is typically through online transfers, ATM withdrawals, or in-person at a branch, though some accounts may offer limited check-writing capabilities.