I’m curious what your thoughts are on fractional reserve banking. It seems to me that this method of banking is a high risk form of financial management on the part of the banks. The difference (sort of) between Maddoff and FRB seems only different by institution: as long as there is more money coming in it doesn’t matter that a small percentage is going out. This system seems based entirely on debt, which is not ideal for a country, I wouldn’t think.

What Ronnie is really asking about is fractional reserve banking, which is the standard practice of pretty much every bank in the modern world.

What’s fractional reserve banking? It’s easiest to illustrate fractional reserve banking by giving an example.

Let’s say a new bank opens up in town and you’re the first person to open an account there. You deposit $100. Then, another person stops in seeking a loan of $80. The bank gives the person that loan, leaving only $20 in their reserves. Of course, the interest rate they’re paying you on your account is low – say, 2% – and the interest rate they’re charging on the loan is likely higher – say, 6%. At the end of the year, they’ll earn $4.80 in interest on their loan to the customer, and then pay you $2 in interest on your deposit, keeping $2.80 for themselves.

Now, if you were to decide that you wanted your full balance back, the bank would obviously be in trouble. They wouldn’t have the money to give back to you, and thus they’d go bankrupt (and you’d have to rely on FDIC insurance).

What actually happens is that a bank has a lot of depositors. Let’s say 1,000 people all deposit $100 in the account, then the bank lends out $80 to a different group of 1,000 people. This would leave $20,000 in their coffers. Thus, even if 150 of the original depositors came in and asked for their money back, the bank would be completely fine.

Fractional reserve banking simply means that a bank is only required to keep a fraction of their deposits on hand – they’re allowed to lend out the rest to people who want to borrow money.

The benefits Without this system, it would be almost impossible to borrow money for any purpose. Loans would basically only exist between individuals – you wouldn’t be able to just go to a bank to borrow money for a car, a home, or to start a business.

At the same time, the idea of a checking or savings account as we know them would go away. We would have to pay a sharp fee for such services – or else keep all of our money at home.

The risks The biggest risk in such a system is the potential for bank runs. If the bank is making poor decisions with the money they’re lending out (or investing), then people who hold accounts at that bank might get nervous and start demanding their money in droves. If enough people tried to withdraw their money at once, the bank would eventually not have enough to pay the depositors and would go out of business. This happened with the Northern Rock bank in 2007 and with IndyMac and Washington Mutual in 2008 – in both cases, the bank showed signs of holding a lot of bad investments, causing depositors to start clearing out their accounts very quickly, driving the banks out of business.

My take On one level, I do understand Ronnie’s comparison of fractional reserve banking to the Ponzi scheme perpetuated by Bernie Madoff – both of them relied on a continual flow of deposits and both collapse if the deposits stop flowing.

The difference between the two is simple, though: Madoff’s scheme could not earn money without new depositors constantly entering the system. He needed new investors so that he could keep paying old ones – and that meant that it was inevitably going to fail.

This system, though, can work forever provided that a large number of depositors don’t demand all of their money at once. Since the rate of interest the banks pay to checking and savings accounts is lower than the rate of interest the banks charge borrowers, the system also earns money in perpetuity, something that Madoff’s scheme doesn’t do.

In short, I think fractional reserve banking is something of a necessary evil, given the benefits (individuals are able to borrow money, banking services are free and often earn depositors some interest).

If this still concerns you… Some people are still left feeling pretty uncomfortable when they learn about fractional reserve banking. If you’re left feeling this way, keep two things in mind:

Your checking and savings accounts are insured by the FDIC. Currently, that insurance is for up to $250,000 – it’s scheduled to drop back to $100,000 at the end of 2009, but that may change. Make sure your account is insured (if it’s in an American bank, it probably is) and hold on to your bank statements, as those may be the proof you need to get your money if your bank were to fail.

You shouldn’t have all of your eggs in one basket. I would personally feel concerned if my account balances were pushing the FDIC limit. Instead, I would be investing some of that money in real estate, stocks, government bonds, or other things – the money will work much better for you there.

However, instead of simply closing out our old checking accounts, we made the active decision to leave both of these open as free basic checking accounts. We left a couple hundred dollars in each account, put the checkbooks from these accounts into storage, and moved on with things.

Why would we leave these old accounts open? It’s simple – they’re backups.

The Purpose of a Backup Checking Account A backup checking account is exactly what it sounds like – it provides an easy solution in the event of an emergency. Here are some situations where it might come in handy.

Identity theft Let’s say your identity is stolen and someone drains all of the money from your primary checking account. During the interim period where you’re trying to get that situation resolved, you’re likely going to continue to need to carry on many banking activities – writing checks, using online banking, hitting the ATM, and so on. This is where your backup account can be useful. Just simply re-route many of your automatic deposits to this backup account for a while and use it as your primary account for a month or two until the situation is resolved.

Emergency money needs Another useful purpose for a backup checking account is for emergency money needs – the balance in the account can act as something of an emergency fund. In a true pinch, you can utilize the balance of this otherwise untouched account to help you make ends meet.

Teller access As more and more people move to using online banking services such as ING Direct (which is the bank I use), they’re often losing some of the convenience that comes with having a live teller available. For simple services such as cashing checks, exchanging currency (turning pennies into dollars, for example), and so on, a live teller can be invaluable. Thus, maintaining a checking account at a brick-and-mortar bank in your community can not only provide a great backup account, but it can leave the door open to many services one might otherwise lose out on.

Getting One Yourself (Without Switching Banks) It isn’t necessary to switch banks to get a backup checking account, although a bank switch is a great opportunity to get one (by leaving your old account in place).

My suggestion? Simply open a very basic free checking account at your local credit union. Get a checkbook for the account, then put those checks in a safe place and then forget about the account unless you have a specific need for it (teller usage, emergencies, or so on).

In effect, this is exactly what I’ve done with my old checking account. It’s now a very basic free checking account, with no maintenance fees or anything else. The account holds a small balance, and the checkbook for the account now resides in a hidden spot in our home. If there’s ever a reason for needing the account, I can simply go grab the checkbook and conduct business as usual, almost seamlessly.

A backup checking account is a personal security measure worth considering. It offers several little advantages at virtually no cost to you, and those advantages tend to shine when you need them the most. Think of it as a bit of security in the face of identity theft risk.

Quite often, though, I had the itch to find something better to do with the money. I eyed putting some of it in CDs (certificate of deposit, which basically means you give a certain amount of cash to a bank for a specified period of time – it earns a higher interest rate than a savings account, but you’re penalized most of that return if you cash it in early), but I didn’t want to lock up a huge amount of it for a long period of time. I wanted to always be able to have that cash when I needed it. After doing some investigation, I decided that a CD ladder was the right move for me.

What’s a CD Ladder?
Simply put, a CD ladder is a collection of CDs bought at regular intervals so that they’ll mature at regular intervals as well. Let’s say I wanted to create a simple CD ladder out of six month CDs. I buy one on the first of each month for six months. Then, on the first day of the seventh month, that first CD I bought matures and I collect a nice return. I can then either buy a new CD for the original amount and pocket the return, just keep all of the return and the original amount for some purchase, or I can buy a new CD for the total return. After that, each month, a CD matures and I can either buy a new one or use it for something else.

If you’re doing this with your emergency fund, you can set it up so that you always have a month’s worth of living expenses available in cash and each of the CDs represents a month’s worth of living expenses. Thus, each month, you’ll have a CD mature, collect a higher interest rate, and you can use the returns to buy another CD (if you don’t need it for an emergency), leaving you with a month’s worth of emergency fund at all times.

Why do this? Why not just keep all of it in cash? The biggest reason is that CDs often return a percent or two higher than your savings account. At ING Direct, for example, the CD rates range from 3.75% to 4.5%, while the savings rate is at 3%. Another reason is that by locking it into a CD, you’re not tempted to spend it.

How Are You Doing It?
I started my CD ladder in September by purchasing three $1,000 CDs out of my cash emergency fund. The total was a bit less than a month’s worth of living expenses. I bought a 6 month CD that returns 3.75%, a 12 month CD that returns 4%, and an 18 month CD that returns 4.5%.

So, in September, I held these CDs:
A $1,000 CD that matures in March 2009 at 3.75%
A $1,000 CD that matures in September 2009 at 4.00%
A $1,000 CD that matures in March 2010 at 4.50%

Notice that the shorter-term CDs don’t return quite as well. Specific rates vary all the time, but it’s a rather constant rule of thumb that longer term CDs return better than shorter term CDs. Thus, instead of just buying a single six month CD, I decided to spread things out to get a better return on at least some of the money.

During September, I kept building our emergency fund as I usually do, putting around 10% of our income into it (which is around 15-20% of our monthly living expenses). I’ll keep doing this for the time being.

At the start of October, I bought three $1,000 CDs again out of the cash emergency fund. This left me with six CDs:
A $1,000 CD that matures in March 2009 at 3.75%
A $1,000 CD that matures in April 2009 at 3.75%
A $1,000 CD that matures in September 2009 at 4.00%
A $1,000 CD that matures in October 2009 at 4.25%
A $1,000 CD that matures in March 2010 at 4.50%
A $1,000 CD that matures in April 2010 at 4.25%

You can probably see where this is going. According to my calculations, we’ll have about four months’ worth of cash living expenses in our emergency fund in February 2009 after buying the CDs each month (remember, I’m still adding cash to my emergency fund). Each month after that, a $1,000 CD matures. I’ll then buy a single 18 month CD for $3,000, which would be enough to sustain my family for a month. And I’ll repeat that for eighteen months.

In August 2010, I’ll own eighteen 18 month CDs which will mature in one month intervals, just like clockwork. If I have my calculations correct, we should still have roughly a month’s worth of cash emergency fund at that point. So, I’ll basically have 19 months worth of emergency fund, almost all of it returning 4.25-4.5% or so.

Here’s what things will look like at that point. I’ll have a savings account with one month worth of living funds in it. Each month, an 18 month CD will mature and the proceeds will go into that account – both the principal and the interest on that CD. At the start of the next month, I’ll buy another 18 month CD worth roughly a month’s worth of living expenses. And as long as we’re able to get by just fine on our normal income, I’ll keep this cycle going, as it’ll serve as a huge emergency fund that also returns at a pretty solid rate.

Why not invest it? This is the typical question I hear about cash emergency funds. Usually, such questions are implying that I should put that cash into the stock market and maybe earn a bigger return. I view this as an investment. Since I’m not saving this money for the long term – it’s a cash emergency fund, after all – I want it to be safe, secure, and stable. It needs to be there for me if I need it.

Another reason for doing things this way Following this plan enables something else interesting as well. When this is actually set up and working, it would enable either me or my wife, without skipping a beat, to go back to school. In truth, my wife is considering the move – she’s looking at perhaps going back to school for a master’s degree in 2010 or 2011. Putting this in place makes such a move quite possible.

If you have a big emergency fund that you won’t need all at once, consider starting a CD ladder with the money. Even a six month CD ladder can create a nice bump in your interest on your emergency fund without adding any risk.

A lot of personal finance books I read suggest putting your savings – especially stuff like emergency funds – in money market accounts. I’ve looked into them but I can’t figure out what the difference is between a money market account and a savings account. Why is a money market account preferable? What’s the difference?

First of all, let’s get some terminology straight. Most of the time, when a personal finance book refers to a “money market account,” they’re talking about a money market deposit account. A money market deposit account is a specific variation on a savings account that many banks offer. Sometimes, the term “money market” is used to describe money market funds, which are an investment vehicle not insured or backed by the FDIC and thus not a place you want to put your liquid cash savings.

Normally, when you deposit money in a savings account, the bank is extremely limited on what they can do with that money. For the most part, the only thing they’re allowed to do with normal savings account deposits is loan that money out to people who need to borrow money, charge the person borrowing a solid rate, and then pay you a part of that rate when it’s paid back. For example, the bank gets deposits that they charge 1% interest on, lend that money out at a 6% interest rate, then keep the 5% difference as their own income (gotta pay the bills, after all).

A money market deposit account is a bit different. The restrictions on what a bank can do with that money are somewhat looser – they can often invest that money in things such as treasury notes, certificates of deposit, municipal bonds, and so on in addition to the tight restrictions of a normal savings accounts. In other words, the bank can take your money and invest it in other investments that are very safe.

For you, the consumer, the differences aren’t that big. Both a normal savings account and a money market account are FDIC insured, meaning the federal government guarantees your deposits up to $100,000. Both types of accounts have some basic restrictions on how often you can withdraw from them, set by a mix of government regulations and bank policies, but for the most part, you’re limited to six withdrawals a month from either type of account.

Commonly, savings accounts at your local brick-and-mortar bank have a pretty low interest rate, but online-only banks (such as my bank, ING Direct) offer rates between 3 and 4% on deposits, with introductory rates sometimes higher than that. Money market accounts offer a rather wide range of rates and these rates often go up and down pretty regularly depending on the investments available to the bank.

Also, money market deposit accounts often have a few additional restrictions and benefits. Some may require a minimum balance; others require you to wait a few days (up to seven) for withdrawals. Some money market accounts, however, allow you to write checks from the account – often up to three a month. Consult the specific policies of any money market account you’re considering to see whether these restrictions and features are present.

In the end, for most people, a money market deposit account is essentially equivalent to a savings account. At your local bank, the money market account is probably a substantially better deal, as local brick-and-mortar savings accounts offer atrociously low interest rates. If you’re comparing with online offerings, though, quite often normal savings accounts offer rates very competitive with money market accounts and offer solid rate stability with no minimums.

Either way you go, savings accounts and money market accounts are the place you should keep your savings, especially if the money is for an emergency fund or another short term goal.

Before I joined ING Direct, though, my primary bank was one of the largest banks in the United States, one that had a branch in the town where I attended college (I won’t name them because of libel concerns, but I’m pretty sure you’ve heard of them). I stuck with them for a long time simply out of habit – the status quo bias at work – but when I started to get my financial life in order, I began to seriously look at the ways that my bank was costing me money:
+ My checking account didn’t earn any interest at all. Just before I moved, they made a big deal about rolling out a 0.25% APY interest rate for the account.
+ The account also had a rather high minimum balance – $300, according to my notes. If you went below that minimum balance at any point during the month, you were dinged with a fee – $2.95 a month, if I recall correctly.
+ They also charged a monthly maintenance fee for a pretty standard online banking service. This fee was $7.95 a month.
+ The savings account offered only a 0.50% APY.
+ While there were a lot of ATMs in town that were fee-free, if you were in a town that didn’t happen to have a bank branch, you got dinged hard with an ATM fee.

These “features” added up to a pretty major money leak, so I went hunting for a new bank. I identified some features I found important (a decent interest rate, free online banking, no fee nightmares) and eventually wound up with ING Direct as my primary bank. Later, I found other features that would be useful (good customer service, a local teller window, etc.) that ING did well in some respects and not so well in others, but they’re still strong enough (and have treated me well enough) that I’m very happy as a customer.

In short, here are the factors I would look for when choosing a primary bank for my personal business, ranked in their order of personal importance. Please, in the comments, if you disagree with the ordering here, let me know why. Quite often, the importance of certain features varies depending on your life situation and experiences.

No (or very low) fees Before I switched to a bank, I’d want to know every fee that I’m going to incur during normal usage of the account. Maintenance fees are an absolute no-no, as they’ll eat all interest I might earn. I also demand a huge network of ATMs that are fee-free, especially in my local area, but also availability nationwide. This is make or break for me – if I get dinged with a fee or two a month, it eats up any interest I might earn and likely also costs me, too.

Some common fees to look for (and avoid) include minimum balance fees, ATM fees, regular maintenance fees, fees for online banking, and excessive overdraft policies. Make sure you know about these fees before you commit to any bank with your account.

Free online banking and bill pay Online banking and bill pay are essential, and the services should be free, too. The ability to pay my bills just by typing in the amount and hitting “submit” not only saves on the cost of stamps, but makes money management easier, too.

Customer service and ease of use Some people tend to pooh-pooh the value of good customer service at a bank. Those who do are ones who have never had a crisis where funds were misdirected by another agency or a similar mess. In those situations, good customer service is worth its weight in gold. For me, I must be able to talk to someone during normal, reasonable business hours. 24 hour customer support is a definite perk, as is the availability of a local teller window.

For day to day use, a bank that’s easy to access at all times without a bunch of hoops to jump through and a clear and easy to use interface makes all the difference. If you use your bank twice a week and a well-designed online banking interface saves you two minutes per session, that’s a savings of three and a half hours over the course of a year.

Generally, this is fairly hard to research when it comes to a bank, as most people generally just complain when service is bad but don’t say much when it’s good. Do some Google searching about the bank’s customer service (like “ING Direct customer service”) and see what you find out.

FDIC insurance This is almost a gimme for any bank in the United States, but it’s still important, and it can be vital if your bank fails, as with the recent trouble with IndyMac. Just make sure that your account is FDIC insured before putting your money in.

Interest rates Almost every article I read online seems to greatly overvalue interest rates, even claiming that one bank is better than another one because of a 0.5% APY difference. In my view, that’s nonsense. Look at it this way: 0.5% of $2,000 is $10. You can easily lose that much to fees in a month. Not having online bill pay can cost you that much in stamps. Poor customer service can cause all sorts of penalties and delays. In my view, all of those are far more valuable than a slight difference in interest rates. A competitive interest rate is required, but once you have that, the minor rate differences are trivial, especially when you consider how often banks alter their interest rates for promotions and in response to Federal Reserve moves. What’s competitive? As of this writing, you should be receiving at least 1% on your checking and at least 3% on your savings. If you’re not clearing that much, then interest is a problem.

A paper checkbook This is actually less important than you might think. I was very hesitant to switch to a bank that didn’t offer paper checkbooks and, for a long time, I held onto my old checking account just to keep paper checks around. What I eventually found was that I simply didn’t use them very much in the presence of online bill pay. I paid most local bills with cash or with credit cards and used online bill pay for everything else. In fact, after going for several months without writing a check at all, I’m about to close that account.

Putting This to Use
The choice of a bank can seem trivial to some, but it’s a surprisingly important choice. From my own personal experience, switching to a better bank saved me about $40 a month in improved interest and reduced fees – that’s $480 a year. Spending an hour or two now to find a better bank – especially if any of the factors above set off warning bells for you about your current bank – will definitely pay off over the long run.

Use the above checklist of features as a starting point. Decide for yourself which features matter the most to you and focus on them. Use Google to find information about the banks you might be interested in – and stick with reputable banks.

My Personal Experiences
I use ING Direct as my primary bank, but I dabbled with other banks for a period of time in order to try them out. Here are notes on my other experiences.

HSBC Direct I signed up with HSBC Direct simply because their interest rate was higher than ING Direct (it usually runs about 0.3% higher than ING) and I was looking for a savings account to sock away my emergency fund. While it worked well as a place to simply drop cash and leave it, the interface was too clunky to serve as my regular online bank. I had repeated difficulties logging on (their system requires you to use a keyboard-like interface with your mouse that has some compatibility issues) and also had a very difficult time initiating and stopping regular balance transfers. It’s a solid place to set up an emergency fund or a savings account for a specific goal, but it’s frustrating to use as a regular bank.

Washington Mutual had the best competition for ING Direct in my experience, offering a consistently higher interest rate on the savings accounts (as much as 0.75% higher than ING), strong customer service, and free paper checks for life. However, their checking account offered no interest rate at all. If I were to carefully manage the account, I could juggle my way around that, but for me, it wasn’t worth the effort, so I’ve just left the account idle. I have considered using it as an emergency fund, however, but as of yet I’ve stuck with the convenience of multiple savings accounts at ING.

My local bank blows away the others on customer service. I can talk to a teller during normal business hours and get services like cashing in change for free, free and immediate check cashing, and immediate resolution on banking issues (I don’t use this bank personally, but am involved with community organizations that do). Unfortunately, their rates are simply not competitive with some of the online offerings. I have considered opening a checking account there anyway just for the convenience of check cashing and change redemption.

Whatever you choose, choose wisely and carefully and do your own research. A poor banking choice can be a constant small drain on your personal finances, while a good bank can not only patch the leaky holes, but provide good service and drop some additional money in your pocket as well.

Because they offer all of these useful tools, over time, I’ve begun to use ING Direct as my primary budgeting tool. I can set aside money in specific small pools, automatically transfer money back and forth, set up automatic bill payments, and so on. These tools allow me to effectively manage my money.

Here’s a walkthrough of how I do it.

Step Zero: Get An Account
You don’t necessarily have to have ING Direct as your bank to do the following. You merely have to have a bank that has online checking and savings access and online bill pay. Many banks offer this – Washington Mutual and E*Trade Financial are two well-known national banks that offer similar services, and your local bank may offer it as well.

Switching to a new checking account is easier than it might sound. I’ll quote the steps you need to take from an earlier post:

1. Open the new checking account. The first step is the most obvious one. Open the account and get the information you need: account number and routing number. Order checks if you need them. In other words, be prepared. Your new bank may also need the information for your old checking account so you can transfer money from the old account into the new.

2. Make a list and check it twice. Make a detailed list of all automated withdrawals and deposits from your current primary checking account. The best way to do this is to simply watch the account for a period of two to three months so that you pick up as many of these as possible.

3. Balance your checkbook. Make sure you’ve accounted for everything outstanding so there are no nasty surprises during the transition. Figure out what you have in the old account down to the cent so that you can avoid overdraft dangers.

4. Switch over all deposits and withdrawals at once. I find this is easiest to do by switching over the deposits a bit earlier than the withdrawals, so that there is money already in the new account when deposits begin to be set up. I’m also incredibly careful about such things.

5. Leave the old account open for a while with a balance in it to catch any missing deposits or withdrawals. Even though it might feel like the balance in the old account is just sitting there wasting time, it’s actually there to protect you against your own poor memory. Just be patient and give it several months; you might surprise yourself.

6. Close the old account. Be sure to leave a correct address behind. You might also want to end other services at that bank, such as a safety deposit box.

If you’re switching to ING’s Electric Orange checking, it may be useful to skip step #6 and leave the old account open, especially if there are no fees on it. I’ve kept my old checking account open for two conveniences – cashing checks with a teller and the ability to write paper checks (on the rare occasions when I do this any more, maybe once every three months).

Step One: Set Up Automatic Bill Payments For Monthly Bills
For every regular monthly bill you have, you can set up an automatic bill payment for that bill so you don’t have to worry about paying it on time. It’s quite simple.

First, click on the “Electric Orange” tab on the top, then click on “Free Bill Pay.”

Add a new business (with the name, address, and account number) by clicking on the appropriate link, then add that bill in below. You can specify the amount, the date to pay it, or the regular date to pay it.

Once you’ve done this, the next scheduled payment shows up in your basic checking account screen, so you can easily see what’s coming up and when.

Step Two: Set Up A Sub-Account For Each Irregular Bill and Savings Goal
What about the other bills, the ones that only come around every several months and seem to always crunch the budget, like homeowners’ insurance or car insurance? For those, it’s useful to set up a sub-account to slowly set aside money so that when the big bill comes, you’re ready. Here’s how.

Once you’re logged in, in the upper left, click on the “Open Account” option. You can see it clearly in the picture above.

Choose to open a new savings account on the next screen The “Open Now” link in the image above is where you should go.

From there, the process is really straightforward – you can call each account you create whatever nickname you like to identify it as a distinct fund: an emergency fund, a “house maintenance fund,” a “vehicle replacement” fund, a “house insurance” fund – whatever works for you.

After that, you should set up an automatic transfer into that account. You can do that by clicking on the Transfer Money tab along the top.

Then, fill out the information below. As with the automatic bill payments, these will appear on your default checking account view so you can quickly see the money that’s going to be automatically withdrawn from your checking account.

My recommendations? I leave the amounts for the regular but varying monthly bills in my main checking account – things like the cell phone bill and the electric bill just come straight out of the checking. Other bills, especially large ones with longer periods like car insurance and homeowners’ insurance, are handled by having a tiny weekly deduction from my checking account into a special fund just for that purpose. For example, our car insurance is about $400 every six months, so I transfer $15 a week into an account just for that. This way, I don’t really notice that $15 going away, but when the big bill comes, it’s not a panic time – the money’s just sitting there. So I transfer it back into my checking and pay the bill, all online.

Step Three: Pay Your Bills As They Come In
After this is all set up, your only real responsibility is to pay the bills as they come in. I usually pay all outstanding bills once a week, on Sunday afternoon. Keep on top of these bills, so that you’re not dinged with a late fee. With many of the bills handled now by automatic transfer, you won’t have that much to deal with – I usually just have one or two bills a week to pay attention to.

Step Four: Use Your Debit Card as a Mastercard and Use It For Regular Purchases Like Groceries
If you wish to completely centralize all of your spending until you get things under control, ING’s Electric Orange checking service will issue you a debit card that also functions as a Mastercard. If you’re just getting your budgeting under control, it may be useful to spend a few months just running all expenses through that card, so you can keep a careful eye on what you’re really spending. Once you have a strong grip on your spending, you can move on to using other mechanisms for your expenses, but sticking with a check card for a while is a great way to make sure your spending is under control.

These steps, all together, create a centralized view of your day-to-day finances and also form the basics of a budget. This is exactly how I do things right now in terms of day-to-day money management. I use ING Direct to do all of those things, and it’s done wonders for keeping my money in line.

This plan requires you to do some basic math with a calculator. Since you’re already at the computer, using the simple calculator tool on your computer for addition and subtraction should do the trick quite nicely. I tend to use Excel because I usually already have it open in order to update my net worth calculations.

Good luck!

Several months ago, I went out to lunch with a couple people who wanted to tell me about a project that they were working on that they thought I might be interested in. They knew of me via The Simple Dollar and, because they were based in Des Moines and I happen to live near Des Moines, they thought it was a great opportunity to get my opinions and thoughts.

Since the lunch was free and I had the afternoon off anyway, I thought, “Why not?” The worst that could happen is that I get a free lunch and listen to some boring conversation. I had heard a few pitches like this before from various people and groups and most of the time I saw very little that would get me excited.

That group was the SmartyPig team, and the set of ideas they’ve come up with is genius.

What’s SmartyPig?
Right now, I use ING Direct as my primary bank. They provide my checking services, my savings services, and all of my online bill pay services. They even allow me to set up sub-accounts so that I can save for specific goals. In my opinion, ING Direct is the best of the full-service online banks, and I’m a happy customer of theirs.

Still, when I look at online services like mint.com, I’m jealous: the idea of sharing saving goals with others is very intriguing. Personal finance and saving money has the potential to be as social as any other activity – we can involve our friends and family in the process and make it a point of conversation and a point of pride.

I can’t help but think back to when I was a teenager and saving for a car. My family was intimately involved in this process, and they encouraged me all the time to keep saving. My dad would occasionally put a few dollars into the account, and my mom would sometimes slip me $5 towards the car when I would take out the trash. Other family members, particularly my grandmother, were quite encouraging as well, and even a few of my friends were in on the story. When I finally got the car (and got it fixed up and road-worthy), it felt like not only a goal I had achieved personally, but a goal I had shared with my family, too – they were happy for me as well as they had seen the progress all the way along.

I’ve often thought that this type of thing would be a very cool feature for an online bank. Why not allow people to set up “public” savings accounts for such goals and then allow others to contribute money to that account and watch the progress? When we were buying a crib for my son, for example, both grandparents wanted to contribute and wanted to know how we were doing in saving for that crib (we were getting a gorgeous one that would be perfect not just for our children, but for their children and so on). One of them even suggested that we have a baby shower themed around the crib we had in mind, but there was no intuitive way to put the pieces together for it.

SmartyPig is basically the solution to this. SmartyPig is basically an online front end for West Bank, a bank chain here in Iowa. It basically allows you to set up savings accounts for specific goals and make these accounts “public” so that others can track the progress in the account. You go in, define a savings goal, set up an automatic savings plan that pulls from your checking account, and then watch your progress towards that goal. The account offers a pretty competitive interest rate, too. When you’ve reached a savings goal, SmartyPig issues you a MasterCard debit card that contains the full balance of your account, and you take it to wherever you want to go to spend it.

SmartyPig took the next logical step, too. They hooked in a number of retailers to kick it up a bit more. Let’s say, for example, you’re saving for a KitchenAid Pro stand mixer and you’re going to buy it off of Amazon when you reach your $300 target. If you specify that as your savings goal on SmartyPig, you’ll get the option of getting that $300 as an Amazon gift card – and they’ll kick on a few extra percent towards the purchase. So, for example, you might get an Amazon gift card at the end with a value of $315 or a MasterCard debit card with a value of $300 – your choice.

My Concerns
SmartyPig is a combination of two very good ideas – the social sharing of an online savings account, plus the option to roll it into a gift certificate for extra savings. I’m left with just a few minor concerns.

First, any time you sign up for another bank account, you’re giving your personal information to at least one more source. While the risk is slight, it does exist – there is no perfect security in the world and your best protection is to always minimize the number of places where your information exists. In a nutshell, I usually need a compelling reason to share my personal information – if it’s there, I’m okay with going forward, but I don’t hand out my information unless I can clearly state the reason and it’s a worthwhile one.

Second, the maximum benefit of SmartyPig comes from consumerism-oriented goals. While you can use it for things like a $5,000 emergency fund, SmartyPig doesn’t lend itself well to goals like that. By its very nature, SmartyPig is for saving for item-oriented goals. While this can be good – it’s a great way to save up for a new washer and dryer, for instance – it can also be bad if you use it to save for extra stuff you don’t really need.

Will I Use It?
For the exact purpose that it fills, SmartyPig is a wonderful online savings option, and I’m using it to save for at least one specific future purchase – a new dryer. Our old one is on the fritz, and this is a very subtle way to get the cash for a new one. My wife is considering adding a new washer to that goal as well. I have not yet shared any goals, mostly because I can’t think of a good idea for one to share.

I will admit to being tempted to set up a savings goal to save for a few frivolous things – and I think that’s one of the dangers of SmartyPig. It’s fun to play with, and my natural instincts are encouraging me to set up savings goals for things like a digital video camera setup.

Should You Use It?
SmartyPig excels at facilitating goal-oriented saving – if you’re saving up for a specific item, this is perhaps the best way I’ve ever seen to self-motivate to get it done and earn some solid returns in the process, both from the interest earned in the account and in the potential gift card you can get when you cash out. If that’s something you struggle with, SmartyPig is a very useful tool for taking that journey. The real question is whether you see a role in your life for such goal-oriented saving – not everyone does, and if it seems pointless and consumeristic to you (which has been the reaction of at least one person I’ve described SmartyPig to), then there’s no need to sign up for an account.

Personally, I think it’s a big help if you’re slowly socking away money for a specific large purchase, and it can be a compelling tool if you’re wanting to share a savings goal with others.

However, for most people the actions of the Federal Reserve seem to have no connection to their day to day life. The prime lending rate? What does that have to do with my day to day life?

First of all, the prime lending rate is the interest rate that banks charge each other for short term loans. If a bank needs some quick cash, it can always borrow it from a bank down the road for that prime lending rate. Thus, most banks use this rate as the baseline for the interest rates they can give on savings accounts (they should be less than the prime rate, or at least close to it) and also on the interest rates they can give on loans (these should be above the prime rate, but competition keeps them low).

Thus, many, many other rates that do affect your life are affected by the prime lending rate. Let’s look at them.

The interest rates on your savings accounts will drop. Your local bank probably won’t change much – they offer so little on the average savings account that it doesn’t matter too much. However, over the next few weeks, a lot of online savings accounts will adjust downwards – probably something close to 0.75% in their savings rate. Some banks will change faster than others, so the next month is a bad time to do any rate jumping. Just stick with where you’re at, know that rates will go down, and wait it out for a bit.

The interest rates on mortgages will drop, perhaps convincing you to refinance. If you were looking at buying a house with a nice, stable thirty year fixed mortgage, this is amazing news because your mortgage rate will drop around 0.75%. On a $200,000 thirty year loan, Ben Bernanke just saved you $71 a month for the next thirty years – a total of $25,635.

That’s a lot of cash, and people out there with a fixed rate mortgage might be interested in refinancing if they can save $15,000 over the life of their loan. It might cost $3,000 or so to refinance, but if the total savings is $12,000 over the loan’s life, that’s plenty of incentive for most people. Incidentally, this will drive a lot of cash into the coffers of mortgage lenders, which will help with the subprime mess.

The interest rates on car loans will drop. This means that if you buy a car in the next few months, the payments will be substantially lower than they would have been without this drop. Since I’m personally thinking about purchasing a van in the early summer, this is good news for me.

The interest rates on variable rate credit cards will drop. Most credit cards have their rate fixed at the prime rate plus some specific percentage – prime plus 11.9%, for example. Since the prime rate just dropped by 0.75%, many credit card rates just dropped 0.75%, which will help a bit if you have a large credit card balance.

In a nutshell, when the Federal Reserve drops the prime lending rate, they’re encouraging you to spend money. Savings accounts become less of a bargain while, at the same time, loans become cheaper. This encourages people to go out and buy stuff.

In terms of stocks, when it looks like people are going to be buying more in the next few months, the stock market goes up, as that means a lot of companies that sell stuff are going to be getting more business.

In short, now is a good time to start thinking about larger purchases that you may need to execute soon. If your car is having troubles, you may want to start investigating good deals on cars, for example, or if you’re looking to buy a home, consider moving forward with that process. That doesn’t mean that you should go out and spend, but instead realize that it may be a frugal time to make a necessary big purchase.

First of all, from their FAQ:

Do you pull my credit if I apply for Electric Orange and the Overdraft Line of Credit?
Yes. As part of your application, ING DIRECT will obtain information about you from a consumer credit reporting agency (a “hard pull”) to confirm that you are eligible for Electric Orange.

So, indeed, the standard practice for people who sign up for an Electric Orange account is that they check your credit report with a hard pull. A “hard pull” generally means about a -5 on your credit score that lasts for about six months, then goes away. MyMoneyBlog has an extensive explanation of hard pulls versus soft pulls.

So where did the idea that ING did not pull one’s credit come from? The story that I have been able to piece together is that when ING first sent out press releases for the account, their official policy was to give everyone a $1,000 line of credit without a credit check. Most of this initial information was sent out in January 2007 and was posted on various banking sites that post press releases and such.

Sometime shortly thereafter, ING changed their policy for new accounts. I spoke to a customer service representative at ING who basically said that this change happened a few months ago, implying that it was likely in February or March 2007. The change stated that ING did have the option to run a credit check at their discretion. Now, the policy is as stated above.

Why did they make this change? I have read many, many reports of people signing up for Electric Orange, immediately “overdrafting” their checking account, and using the overdraft protection as another credit card, which was not the purpose of the account at all – it was intended as an occasional protection against overdrafts. I would strongly speculate that this behavior warranted the change in policy from ING.

What can we learn from this? First of all, know what you’re signing up for, no matter what. If you read a four month old press release on a product, sign up for it without reading the documentation, and find out that things have changed, you’ve made a bad move. Don’t rely on second-hand information ever – investigate for yourself. Blogs like these are meant to get you thinking and point you in the right direction, but you have to do the investigation yourself.

Second, you need to ask yourself if a credit check like this is an issue for you. The credit protection offered by this account is exactly what I want. I’ve overdrafted once in my life and it was due to a mathematical error – but it ended up costing me almost $100 to deal with. With Electric Orange, it wouldn’t cost me a thing other than a few cents in interest. Plus, the account balance itself earns a 4.00% APY. My credit is stellar, so I’m not bothered by the credit check, but if your credit is poor or you’re sweating every single point on your score, this could be an issue for you.

What is Electric Orange?

Electric Orange is an online-only checking account offered by ING Direct. In short, that means you do all of your checking account business either online or with a debit card. For some people, this sounds like complete craziness, but bear me out.

What’s Good?

A 4.0% APY interest rate This checking account earns an interest rate higher than inflation. My average checking account balance over 2006 was just north of $4,000. In this account, that’s an earnings of $160, just for having Electric Orange.

A strong fee-free ATM network My ATM card has no fees if I use an ATM in the AllPoint network, which has several locations nearby and apparently has one in all Target stores. My previous bank had an extremely limited fee-free ATM card network.

An overdraft line of credit Instead of incurring a big fee if you overdraft, the account instead offers a line of credit and they just begin charging you interest on that credit line. The credit line seems to be set differently for different people depending on their initial deposit and any balances they might have in other ING Direct accounts, but the interest rate on the line is 12.25%. Thus, if you accidentally overdraft your checking, instead of charging you a big fee (my old bank charged $40), you just start owing interest on the amount that you overdrafted. If you deal with it quickly, it’s just a few pennies.

Extremely user friendly online banking ING Direct has very good customer service and the best overall online banking interface I’ve used. Online bill pay with them was incredibly easy – I was paying my bills online very quickly and it all worked smooth as silk, even to rather local institutions like the local telecommunications cooperative.

What’s Bad?

No paper checks This is probably the worst drawback, but so far it hasn’t been as bad as I feared. I left my old account open with about $100 in it for small incidental checks (the nearest grocery store to my residence only accepts cash and checks from local banks as payment). For other checks, the online interface allows you to fill out a form that looks like a check and then they will mail you a check first class the following day. For me, I receive the check about four postal days after filling out the form online. This works for some larger check situations, but it’s not the most flexible system in the world. So far, it has worked fine for me, but I can envision a situation or two that might cause me trouble.

No branches The biggest reason for this for me was that my local bank allowed me to deposit pocket change directly into the account using their counting machine. Thus, I would save up pocket change in a jar for several months, then deposit it all at once. By keeping the old account, I retain this service. Other than this service, I never used a branch, so for me, this issue with Electric Orange is basically nonexistent.

Am I Going To Stick With It?

I have been very happy with ING Direct’s online savings in the past in terms of customer service and their nice interest rate, so it was a no-brainer for me to give this a try. So far, I love the account. I haven’t been hit with a single fee of any kind as of yet (and they used to come in all the time with my old bank) and I’ve earned a pretty nice little piece of interest. If you figure the losses on the fees at my old bank (and the lack of interest) versus the lack of fees at this bank and the solid interest rate, it is a very good deal.

What about a recommendation? If you’re comfortable with online bill pay, then this is the type of checking account you should be moving to. If you prefer to write checks for your bills, then this account will cause you much frustration and isn’t worth it. The online bill pay factor is really the deciding factor here.

Fire up your spreadsheet and enter the following information into cells:
In A1, enter Simple Mortgage Calculator
In A3, enter Amount Borrowed
In A4, enter Length (in Years)
In A5, enter Interest Rate
In A7, enter Monthly Payment
In A8, enter Number of Payments
In A9, enter Total Interest
And in A10, enter Total Loan Cost

That’s a lot of labels. We’re going to use the first three numbers to calculate the last four, so enter some dummy values in B3, B4, and B5. I used $180,000, 30, and 8.00%. Then we begin setting up the calculations:

The piece in B7 looks really strange. This is what should be typed in:

=-PMT(B5/12;B4*12;B3)

If you’re using Excel instead of OpenOffice, it will look just a bit different:

=-PMT(B5/12,B4*12,B3)

This PMT function is a part of the spreadsheet that calculates how much a monthly payment will be for you. The interest on each payment will be 1/12th of the annual rate (hence the B5/12 part) but you’ll be making 12 payments a year (hence the B4*12 part). The number that appears here is the actual cost of a monthly payment given the terms you set up in B3, B4, and B5.

The other three numbers are fairly straightforward:
To calculate the number of payments (in cell B8), enter =B4*12
To calculate the total interest paid over the loan’s lifetime (in cell B9), enter =(B7*B8)-B3
To calculate the total cost of the loan (in cell B10), enter =B7*B8

In the end, you’ll get something that looks like this:

You can change the first three numbers however you want to look at various different possibilities. Want to make it even cooler? In cell A13, write Month 1, then click and drag the black square down from that cell until you can see month 360. Then, in B12 through E12, add these labels: Starting Balance, Payment, Interest Paid, Principal Paid, and Ending Balance. Yep, we’re going to see what exactly each payment is doing.

To set up the numbers, you’re going to have to enter some more formulas into the first couple rows of this little table, but after that, you can just drag down to fill in the rest.

In B13, in order to set the starting balance for the first month, you want it equal to what you entered above, so enter =B3
In C13, you’ll want it to always equal the payment calculated above, so enter =$B$7
In D13, you want to see how much interest you paid that month, which would be 1/12th of the annual interest (set permanently in B5) on the current balance, so enter =B13*$B$5/12
In E13, you’ll want the amount of principal paid this month, which is just the difference between the total payment and the interest paid, so enter =C13-D13
In F13, you’ll want to calculate the balance at the end of the month, which is the starting balance minus the principal paid, so enter =B13-E13
And finally, in B14, you just want the same starting value as the ending value from last month, so enter =F13

You can click on the cells B14, C13, D13, E13, and F13 and drag the black square in the lower right of each one all the way down until it lines up with Month 360. Don’t worry about weird values until you’ve done all five columns.

When you’re done, you’ve got a full mortgage amortization calculator – and you understand completely how the math works! Be sure to save this file for later – it’s useful!

Now that you’ve assembled your own mortgage calculator, you can see that the possibilities of using spreadsheets to do personal finance calculations are endless. Good luck!

You’ll end up with something that looks like this.

You’ll notice that in B6, I’m about to enter =B4/12 … what does that mean? That’s simply how to figure 1/12th of the annual rate of interest, or the piece of the annual interest that happens in a single month. When you enter that formula in the cell, you’ll see the number zero. Don’t worry, just click on that cell, go up to the Format menu above, choose the Cells option on that list, then in the popup box choose Percent and have it show two decimal places. After you do that, you’ll see a value of 0.42%, which is the actual monthly interest rate if the annual rate is 5%.

Now, if you’re doing annual compounding, a calculation is very easy. In cell A8, write If annual, interest is: and then in B8, enter =B3*B4 … you’ll see that with annual compounding, you’ll earn $1,000 in a year.

If you’re doing monthly compounding, though, it’s a little different. To see this in action, you’re going to have to set up some more labels:
In A10, enter If monthly:
In B10, enter Balance
In C10, enter Interest
In A11, enter Month 1, then click on the cell and drag the little black square in the lower right of the cell downwards until you can see all the months up to Month 12.
In B23, enter interest is:

You should have something that looks like this:

Now, the math. For the first month, the balance is the same as the amount, so enter =B3 in cell B11. How much interest will that earn in a month? Enter =B11*$B$6 in cell C11 to find out; for our example, it’s $83.33. If you were to multiply this amount by 12, you’d find that it is $1,000, which is the same as the annual interest earnings.

But things change at the start of the next month: it compounds. In B12, enter =B11+C11 … and then click on that cell and drag the black square down until it’s lined up with Month 12. Do the same in the C column, starting with cell C11. You’ll notice that each month, the interest earned is a little higher.

So how much did you actually earn in the year using monthly compounding? In cell C23, enter =SUM(C11:C22) … this formula basically says add up everything between C11 and C22. The total in our example is $1,023.24.

Right now, you’re seeing the difference between APR and APY. APR is the annual percentage listed above: 5.00%. However, APY is not equal to that. If you want to figure out the APY here, type APY in cell B25, and in cell C25, enter =C23/B3 … and then reformat the cell to be a percentage, as mentioned above. You’ll get a value of 5.12%.

Whenever a bank mentions an interest rate to you, they’ll give you the APR when they’re lending you money but give you the APY when you deposit money with them. To the uneducated, it makes the offer seem better, because almost everyone outside of the financial industry uses these values interchangeably. Thus, when you see a savings account with a 5.05% APY, the actual interest rate they’re giving you is lower; you can just earn a 5.05% overall return if you don’t touch the money at all.

Next time, we’ll take a look at mortgages and build a simple mortgage calculator.

I originally wrote this all as one post, but I’ve since split it up into several, which will be posted in order throughout the weekend. If you found this piece enlightening, check back at the end of the weekend and there will be plenty of interesting things to try out!

Also, be aware that this first entry is intentionally very simple so that people who are unfamiliar with spreadsheets can follow along. If you know the basics of using a spreadsheet and the very basic idea of compound interest, this will probably seem very basic for you. That’s fine; tune in later and we’ll be kicking things up a notch.

Anyway, in the interest of saving money, I’m going to use OpenOffice Calc for these examples. For most things such as this, it is functionally identical to Microsoft Excel, so if you have a copy of Microsoft Office, you can basically follow along with these examples. I attempted to use Google Spreadsheet for examples, but it was quite frustrating to use for repetitive calculations. OpenOffice Calc is free, open source software; you can get it for free at OpenOffice.org.

Got a spreadsheet now? Let’s get started.

What is interest? Interest is the “rent” paid to borrow money. When you put money in the bank, you are essentially lending your money to the bank so that they can use it for various investments. In exchange for that, they pay you a small amount of interest. Similarly, when you use a credit card, you are borrowing money from a bank, and for their investment in you, you must repay that investment with interest.

What is compound interest? Compound interest means simply that rather than directly giving the interest back to you, it is instead added directly to the amount of money you loaned or deposited. After that interest has been added to your balance, your balance is now higher, and thus the new balance earns more interest than before.

Let’s get started and see how this works. Fire up OpenOffice Calc (or Excel). You’ll see the following screen:

This is the default screen for OpenOffice. If you’ve ever used Excel or any other spreadsheet, this should feel familiar; if you haven’t, play around for a bit. You’ll find out that each little rectangle can be filled with information. This is really cool because we can make those rectangles do automatic calculations for us really easily, and those calculations can really illustrate what’s going on with our money.

In the first four cells of column A, I’ve entered a few labels. These will be used to describe the data we’ll put in column B to the right. You’ll see that cell A4 is highlighted (it’s called A4 because it’s in column A and row 4 – look to the left of the row to see the number and to the top of the column to see the letter) and in the lower left there’s a little black square. If you click on that little black square and drag downwards, you’ll see that the spreadsheet will automatically fill in more years for you. Nifty! This auto-fill feature saves a ton of time for doing repetitive calculations as we’ll see in a bit.

We want to do some compound interest calculation, so we need to enter a balance (put this in cell B1, to the right of where we labeled “Balance”) and an interest rate (in B2, just to the right of the “Interest Rate” label). You should be sure to put a percent sign at the end of the interest rate value so the program knows you’re talking about a percentage and you might want to also put a dollar sign in front of the balance amount so the program knows you’re talking about dollars. When you’re done, things will look something like this:

Notice that in cell B4, I’ve also written =B1+B1*B2 … what does that mean? I’m telling the program that in this cell I want to see the value in B1 (the balance) plus the value in B1 multiplied by the value in B2 (the interest). This is the basic interest calculation: we want to see the original balance (B1) plus the interest earned a year (B1*B2). If you type in =B1+B1*B2 into that cell and hit enter, you’ll see the result of the calculation: $10,500.00 in this case.

Here’s the neat part, and this will hopefully begin to show you the power of a spreadsheet. Go back up to B1 and change the balance to something different. As soon as you do that, the calculated balance in B4 automatically changes! You can change the interest rate in B2 as well. Throw in all kinds of numbers to see what happens.

Now we’re going to see what happens in year two. This time, in cell B5, we’re going to enter the formula =B4+B4*$B$2 … that’s a bit different than before. Just bear with me for a minute. When you enter that formula, you’ll see that it takes the value in B4 and uses that as the initial balance to calculate the second year’s worth of compound interest, giving you a new balance of $11,025.00 in this example.

Now, click on B5 and then click and drag down on that black square in the lower right, all the way down to the label for Year 20. When you let go of the mouse button, you’ll see that the calculation for all of the years is done. This is why we did the $B$2 part; the program knew to automatically change the balance each time, but we wanted to tell it to always point back to B2 for the interest value no matter what. You can jump back up to the top and play with the interest rate and the balance to see compound interest at work. You can keep dragging down for as far as you wish, but after a while you start looking at numbers that aren’t really feasible for your lifetime.

If you want to see how much interest is actually earned each year with compound interest, just start another column off to the right as pictured above. In the Year 1 row in cell C4, enter the formula =B4-B1 to see how much interest was earned in year one…

… and then enter =B5-B4 in cell C5 to calculate how much is earned in year two. Once you’ve done year two, click on cell C5 and then drag that black square in the lower right of the cell down again to automatically calculate the earnings for all of the other years. See how that money grows? That’s the power of compound interest.

Next, we’ll tackle the idea of how monthly compound interest works, learn what the difference is between APRs and APYs, and see how that affects you.

Why did you have all of those fees? Admittedly, my fee count was higher than most, but that was mostly due to traveling. I used several out-of-network ATMs that month, mostly to have cash on hand for incidentals, and the fees really began to add up.

The worst ones? I would withdraw $20, pay a $1.50 fee from that ATM’s bank, pay a $2 fee from my own bank, and pay a $0.14 sales tax on that fee. Total money lost on a $20 cash withdrawal? $3.64, or an 18.2% fee. That’s worse than buying something on a credit card and leaving it there for months.

Here are five tips for avoiding a pile of unnecessary ATM fees.

Use your ATM card (where you can) directly for purchases. Most ATM cards today are also check cards, meaning they work as credit cards almost everywhere. Instead of using an ATM card and suffering those fees, use your check card for the purchase directly and avoid the fees. The vast majority of banks provide this for free, so you should use it.

If you have other options to pay besides using your pocket cash, use it. I generally reserve cash itself for situations where that is the only solution (tips, paying the pizza guy, and such). Otherwise, I try to use my cards as much as possible. If I use a credit card for something, I make sure to pay off the balance ASAP.

Know your network. Most ATM cards have a network logo on the back so you can easily identify whether or not a given ATM machine can be used without fees. Know that logo so you can quickly tell if a given machine will work for you. If not, strongly consider other ways of making the purchase that you wish to make.

Keep some pocket money at all times. Don’t expect to spend this money unless you have no other choice. I usually keep a pair of twenties (and a few smaller bills) folded up in a back pocket of my wallet for such events; it’s generally out of sight and out of mind until a vital situation comes up.

Keep your head on straight when it comes to finances. If, after all this, you still feel the need to use an out-of-network ATM, use the ten second rule and consider whether or not the item you’re considering buying is really necessary. Could you live without it (and also without that extra ATM fee)? The answer is probably yes.

I rank these criteria in the order I value them; thus, a winner in the first two criteria will overcome another bank that wins in everything else, for example. If you want to “score” banks, give 4 points to the first criteria’s winner, 3 to the second, 2 to the third, and 1 to the fourth.

1. FDIC insured accounts. If a bank’s accounts are not FDIC insured, I won’t bank there, period. FDIC insurance guarantees you up to $100,000 of your money back in the event of a collapse of your bank. Most young people aren’t aware that banks are businesses and they indeed do go out of business, so this insurance means that the federal government is insuring you against the event of a bank collapse. As a depositor, this is essential, because in the event of another savings and loan crisis, you have a huge risk of losing everything. Thankfully, almost all banks today are FDIC insured. If you don’t know, check with them.

2. Fees. Fees trump almost everything else about an account, and it doesn’t take much at all to make one bank a huge clear winner over another bank. Here are some common bank fees to look out for; if you’re comparing accounts, make sure you know what these fees are going to be for each account and also have a good idea of how often you’ll be dinged for them:

Overdraft fees
ATM fees
Out-of-network ATM fees
Transaction fees
Maintenance fees
Online banking fees
Online bill pay fees
Minimum balance fees

Before you even consider opening a new checking or savings account, be aware of all of the fees you may be charged with. This is especially true if you’re being tempted to jump to a different account because of a higher interest rate, because if they charge more fees, you’ll end up losing ground overall.

3. Customer service. Many people undervalue this, particularly for savings accounts, but customer service makes a huge amount of difference when you’re trying to execute transactions. Are transactions easy to execute? Are they immediate, or is there a delay? Is it easy to talk to a customer service representative on the phone? Customer service is a huge advantage that brick and mortar banks generally have over online banks, as you can simply stop by a branch and have your questions answered and issues resolved, which is particularly important if you have documents to sign, change to sort, or other such service needs.

4. Interest rates. Interest rates matter, but they are completely trumped by fees and partially trumped by customer service. Take, for example, EverBank. Their checking account interest rate of 6.01% APY is stellar. However, they have no ATMs of their own, which means you get dinged with a $1-$3 ATM fee every time you withdraw cash. They will reimburse you up to $6 each month to cover part of this, but this recurring fee basically eliminates the interest rate advantage that their accounts offer in my situation. If you are in a situation where you never use an ATM at all, then this fee is negligible, but it’s easy to see why fees trump interest rates.

If you’re considering switching, be sure to compare all of your options using the above criteria. More than anything, though, don’t overvalue the interest rate. You should be quite willing to accept multiple points lower in interest rate in order to minimize fees and maximize customer service.

Let’s say that on January 29, 2007, Bill opens an account with HSBC Direct and deposits $100 in it. Bill wants to build an emergency fund, so he schedules a $100 deposit each week. I’m also going to simplify HSBC’s method of making interest payments just a bit, and say that they deposit all of the interest from the previous month into the account on the 22nd of each month, which is roughly accurate.

On May 1, Bill wakes up and checks his account. With the old rate of 5.05% APY, Bill would have earned $8.87 in interest over the period. With the new introductory rate, Bill earns $10.53 over the period, meaning the introductory rate earns Bill an extra $1.66 in interest. That’s not bad, considering the relatively small amounts that Bill’s working with.

However, the best way to leverage this feature is to deposit a large amount into the account. Let’s say Jill deposits $50,000 into her HSBC account next Monday morning, February 5. She heard about the interest rate and wants to capitalize on it. On May 1, Jill checks her balance. With the old 5.05% APY, Jill earned $576.38 on her money, but with the introductory 6.00% APY, she earned $684.45 in interest, a difference of $108.08.

What’s the drawback? There are two big drawbacks with this offer: it only affects new deposits (meaning that money already in your HSBC account gets the old 5.05% APY – and by new they mean anything over your balance on January 29, so a withdrawal and redeposit won’t help) and it ends on April 30. For me, it’s not enough to make HSBC my primary savings account for my emergency fund, but as a person who uses HSBC for a small savings fund, I quite like the extra money.

However, if you’ve never tried out an online savings account before, this is the most lucrative offer I’ve heard of, and it’s from one of the leaders in the field, backed by the FDIC and by one of the largest banks around. Just visit http://www.hsbcdirect.com/ and see what you think.

I did the footwork for you, and here’s the list of Money Magazine’s 35 Outrageous Fees. Each one is linked to the appropriate page on the CNN/Money site so that you can jump straight to the information about that fee. After the list is a bit of general commentary.

1. Airlines: Paper tickets
2. Airlines: Talking to a person
3. Changing your flight
4. Airlines: Reserving an aisle seat
5. Overpacking
6. Car rental: insurance
7. Car rental: excise taxes
8. Hotel fees: Internet connection fee
9. Hotel fees: Resort fee
10. Hotel fees: Automatic gratuities
11. Hotel fees: Package delivery fees
12. Hotel fees: Mini-bar restocking
13. Phone surcharges: Carrier cost recovery fee
14. Phone surcharges: AT&T’s tax-related surcharge
15. Phone surcharges: Property tax surcharge
16. Phone surcharges: Activation fee
17. Phone surcharges: Cancellation penalty
18. Gift card activation fee
19. Junk closing costs
20. Title insurance
21. Biweekly payment fee
22. ATM fees
23. Monthly service fee
24. Bad deposit fee
25. Foreign currency fee
26. Credit card late fees
27. Balance transfer fee
28. Over-limit fee
29. Same day payment fee
30. Mutual fund fees: Index funds
31. Mutual fund fees: Large U.S. stock funds
32. Mutual fund fees: Target-date retirement funds
33. Variable annuity expenses
34. Brokerage transfer fees
35. 529 expenses

It’s a good list, but most of these “outrageous” fees boil down to consumer irresponsibility, unfortunately. Many of these are due to violations of clearly-stated policies by companies; just follow their policies and use some common sense and you’ll skip right over many of these fees. However, there is one fee that really irritates me that isn’t listed here: a fee to deposit loose change into your savings/checking account.

Given that, I’ve prepared a plan for moving to a new checking account that should pave the way to making the transition substantially easier than it was the last time I attempted this feat. Here’s what I plan to do.

1. Open the new checking account. The first step is the most obvious one. Open the account and get the information you need: account number and routing number. Order checks if you need them. In other words, be prepared.

2. Make a list and check it twice. Make a detailed list of all automated withdrawals and deposits from your current primary checking account. The best way to do this is to simply watch the account for a period of two to three months so that you pick up as many of these as possible.

3. Balance your checkbook. Make sure you’ve accounted for everything outstanding so there are no nasty surprises during the transition. Figure out what you have in the old account down to the cent so that you can avoid overdraft dangers.

4. Switch over all deposits and withdrawals at once. I find this is easiest to do by switching over the deposits a bit earlier than the withdrawals, so that there is money already in the new account when deposits begin to be set up. I’m also incredibly careful about such things.

5. Leave the old account open for a while with a balance in it to catch any missing deposits or withdrawals. Even though it might feel like the balance in the old account is just sitting there wasting time, it’s actually there to protect you against your own poor memory. Just be patient and give it several months; you might surprise yourself.

6. Close the old account. Be sure to leave a correct address behind. You might also want to end other services at that bank, such as a safety deposit box.

The Positives

The Interest
For any balance, Electric Orange offers a 3.00% APY interest rate. This means while money is sitting in your checking account waiting to be withdrawn to cover bills, you can earn 3.00% percent on it. If you have a lot of cash on hand (above $50,000), the rate jumps above a 5% APY, which is approaching certificate of deposit rates just sitting in your checking. That’s truly impressive and is the real calling card of the Electric Orange account.

Free ATM Access
The account offers a MasterCard debit card that also functions as an ATM card. Nothing special, except that the card is part of AllPoint, which means that there’s a huge number of ATMs all over the United States that you can use this card at with no fees. I checked the list and there are usable ATMs all over near where I live that can use the card.

$1000 Overdraft Line of Credit
As if those features weren’t enough, the account also offers a $1,000 overdraft line of credit, which means they’ll cover any minor overdrafts for you automatically with no fee, instead just charging you a finance charge for the amount that you overdraft. This makes money management a bit easier for some, but with that kind of interest rate, I won’t feel so bad about leaving plenty in the ol’ checking account.

Competition
The existence of this account is going to really shake things up in the checking market – I expect that other banks will again be following ING’s lead and offering similar rates and features. With features like these, the consumer wins.

The Negatives

No Local Branches
I don’t mind using ING for savings, but I often use my local bank for additional services that largely require a teller unless you want to pay a fee elsewhere. What if I want to acquire $60 in quarters (this happens regularly for me, as I often play poker with dimes and quarters with friends)? What if I want to just immediately cash a check without delay? It’s going to be hard to do these things without any local branches.

No Checks
This is the one that really worries me. The Electric Orange account doesn’t allow you to actually write a check. If you actually need a paper check, you have to request one online and wait for them to print it and mail it to you. This isn’t a problem if you exist in a mostly checkless environment, but I live in a rural area where many people (including the local grocery) only accept cash or check for incidental payment.

And The Conclusion

I admit it – I’m unsure about what to do. My thinking right now is to switch to it as my primary checking, but maintain my old checking account with a small balance in it for the check-writing convenience, and transfer money to the old checking from time to time when I need to. This would enable me to take advantage of their tellers for check cashing and change needs as well.

If you have any thoughts, I’d love to hear them.

I wanted to calculate this out to see whether or not this is true and to determine whether or not you’re saving money by using ING versus HSBC over a period of one year. Obviously, for longer term investments than this, you should be considering a certificate of deposit; if you’re moving funds pretty regularly, then service becomes a bigger factor and the balance shifts more toward ING.

First of all, I need to convert the stated APY on each account into the actual earned interest rate. ING’s APY of 4.4% becomes an interest rate of 4.314% when compounded monthly, while HSBC’s APY of 5.05% actually amounts to an interest rate of 4.937% when compounded monthly.

So, how much would you have to deposit in HSBC for the superior interest rate to overcome ING’s $25 “signing bonus”? To calculate this, I set up an Excel spreadsheet with ING’s interest rate and HSBC’s interest rate as static values and a cell in which I could enter different initial deposits. The spreadsheet would then take this initial deposit, calculate the interest each month, and then produce a difference between the totals at the end of the year.

At first, I entered $250, the minimum amount needed to get the ING signing bonus. At this level, at the end of the year, the ING account held $24.38 more than the HSBC account. Not bad.

Next, I tried an initial deposit of $10,000. At this level, the HSBC account held $38.99 more at the end of the year. A win for HSBC.

So, the correct number had to be somewhere between these two amounts. After entering many different values, I found the sweet spot: in order to overcome the ING “signing bonus” in a single year, a person would have to make an initial deposit of $4,002 in an HSBC Direct savings account.

What does this mean? If you discard all other factors, the ING signing bonus means that ING is the best solution for beginning savers, whereas if you have a large principal, you’ll make more at HSBC. The cutoff number for one year’s worth of saving is $4,002; for longer periods, other investment options are likely to beat either bank.

In my opinion, ING is much stronger than HSBC on service-related issues, which is clearly a factor to take into account when selecting your savings account. I stand by my recommendation that ING is the best choice for beginning savers; for those with large balances, other options besides online savings might be better yet.