The following is adapted from “Your Money Vehicle.”
The big day is here — the day you’ve been waiting for all week: payday!
You follow the standard procedure. You get your hands on your paycheck and then head to the bank to deposit it. Or, perhaps you open up your banking app and use it to deposit the money into your bank account.
But what happens next?
If you’ve ever wondered what happens to your money after you deposit it into your bank account, or wondered if you even should put your money in a bank account, read on.
Where should you put your money?
Your Money Vehicle is no different than your actual vehicle in that at the end of the day, you want to park it in the safest possible place.
So, where is the safest place to park your car? Probably in your garage, if you have one. Your garage will provide safety, easy access, and even some intangible rewards, like not having to scrape off snow or ice during the winter.
What about your money? Where’s the safest possible place to park your cash? You may think you have only two choices: Under your mattress, or in a bank.
Hopefully, you’ll agree that the days of stashing money under mattresses or in a hole in the backyard are over. These days, the safest place to park your money is in a financial garage — or a bank. Like an actual garage, it can provide many of the same benefits.
Using a bank: Advantages
Perhaps the biggest benefit of putting your money in a bank is the protection and peace of mind that comes from knowing your money is safe.
When your money is in a bank, there is no longer a concern surrounding the location and tracking of your cash. A bank has the capability of showing you exactly where every dollar goes, and in most cases, even providing some tools to help manage your spending.
The bank will also provide your money with a layer of security that cannot be found under your mattress. In fact, the Federal Deposit Insurance Corporation (FDIC) will insure up to $250,000 per person in each of your accounts, if they qualify. Checking, savings, CD, and money market accounts will be insured — but it is always best to ask your bank for more details.
Will it be harder to access my money in a bank?
You would think that handing your money over to someone at a bank would make it less accessible, but part of a bank’s value is that the money you deposited is that it’s easy to get to. This easy access is called liquidity. Liquidity is the ability to access your money in person or electronically whenever needed; this can be done at your local bank, ATM, or online.
So, even though you may no have cash in hand, it’s usually as easy as a trip to the ATM to get your money out of the bank.
Don’t forget about interest!
If you are not yet sold on opening a bank account, the next advantage may just convince you: The bank ends up paying you money!
In any relationship that involves a borrower and lender, the lender receives a fee, called interest. When you deposit money into an account at the bank, you become the lender, and as a result, will receive interest. How much interest, exactly, is calculated as a percentage of the money you deposited. Generally, the more money you place in an account, the more the bank will end up paying you.
But what happens to my money?
This next part might sound alarming, but don’t worry, it’s not.
When a bank offers you a small, guaranteed interest rate to take possession of your money, it is because they believe they can find a higher return elsewhere. In other words, when you deposit money, as mentioned, you become a lender, and the bank becomes the borrower. But then, the bank turns around and uses that money to invest or loan it out to make more money.
For example, in your bank account, you might receive a guaranteed 1% interest rate. The bank believes it can go out into the market and find an interest rate higher than that 1%. By taking your money and either placing it into an investment or lending it out, the bank accepts the risk and the reward.
So, you may deposit $1,000 at 1% interest. A borrower asks the bank for an $800 loan — the bank then loans out that money at 4% interest. That’s enough to pay you, the depositor, and to make money by loaning your money out.
How can banks do that?
Technically, banks are only required to keep a certain amount of physical cash on hand at their location, which is called the reserve ratio, or reserve requirement. This amount goes up to 10% of its liabilities or total deposits. For example, a bank may have $1,000 in deposits, but is only required to have $100 in cash for customer withdrawals.
The only time a bank runs into trouble is if all of its customers show up at once looking to withdraw cash. That’s called a bank run, and if bank runs are happening, there are probably bigger problems in the world than low cash reserves.
You may remember the bank run scene from the movie “It’s a Wonderful Life”:
Even so, the bank is a business, and it takes risks to make money. Why you use a bank is because of the rewards and security it offers. So, before you stuff your cash under your mattress, know that your money will grow faster, be safer, and be more accessible with a bank than it ever will be hidden away.
Because if your mattress catches fire one day with a stack of cash underneath it, you can bet your bottom dollar that the FDIC will not insure it, and you’ll be out of luck.
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