23 April 2007

Dikkii's financial tips #2: Why are there so many different bank accounts?

Welcome to Dikkii's financial tips.

This is a series where I attempt to provide some sort of guidance to financial matters without breaching the Corporations Act by actually providing advice.

Today, we were going to look at bank fees, but they're going to make more sense if, before we do, we look briefly at bank accounts first. It is vitally important, that in this day and age, if you want to cut your bank fees, you must know what bank accounts you need, and what fee structure they're on. Only then should you be addressing the issue of what level of interest you'd like to generate.

Part of most people's misconceptions about bank fees come from the fact that they have entirely the wrong set-up for their accounts in the first place. This blogger has a weird and wonderful bank account set-up - if truth be told, I have a couple more bank accounts than I need, but then again, I don't pay any account keeping or transaction fees, so there's no loss there.

This post aims to have a look at why different bank accounts evolved, and what their purposes are.

We're going to look at deposit accounts, first. These are a bit more straightforward than lending accounts, and are what most people start their lives off with first. And we'll try to cover off on the main types:

  • Transaction and cheque accounts
  • Term deposits
  • High interest savings accounts
  • Cash management accounts
  • Cash management trusts
  • 24 hour accounts & 11AM accounts
  • Online accounts

There are other types of bank accounts out there, but these are the main ones for personal investors.

1. Transaction and cheque accounts

These evolved from the old savings accounts and the old cheque accounts, which don't really exist anymore except in archaic, inconvenient and costly formats, such as passbook accounts.

Transaction accounts exist to provide day-to-day access to money - a sort of entry and exit point into and out of the banking system. Without one of these, you have very few ways to access your cash as and when you need it.

These days, you're sunk if you don't have ATM and EFTPOS access - which is what these accounts aim to provide. Most of them also provide a cheque facility on the side, should you need one and this is one reason why cheque accounts in their old form have largely disappeared. The cheque accounts of today are merely transaction accounts with a cheque facility.

Also, like most of the accounts in this list, transaction accounts should have phone and internet access.

Most transaction accounts pay minimal interest, if any. They are designed for transacting, nothing more. Keeping large wads of cash in these is usually a transitory thing.

2. Term deposits

These are pretty much the only type of deposit account that still exists intact from the "good old days". Essentially, a term deposit pays a fixed rate of interest for a fixed time frame.

There is pretty much no access to a term deposit until it matures - if you do, expect to pay an interest adjustment, which is normally unfavourable, and an administration fee which could be as high as $50. One should really only consider term deposits if they need to lock away a sum of cash for a short to medium term time frame with no requirement to access any of the funds. What if you need these funds in a hurry?

Another thing to be aware of when using term deposits. You are having a bet that interest rates will not increase over the time frame that your funds are invested. If interest rates increase, you have no one else to blame other than yourself if you start moaning about better rates that might be available in the future. This is a risk that you are taking when locking into one of these products.

3. High interest savings accounts (HISAs)

These appeared in the early nineties as a way of getting depositors to save. Most of these pay a bonus rate of interest should you satisfy some criteria.

It's interesting to note that they evolved from a specialised account which was known by some providers as the "Christmas Club Account". These were highly restrictive, yet effective HISAs.

The most common criteria appears to be a requirement that there be at least one deposit per month and no withdrawals in order to satisfy the eligibility requirements for bonus interest, but some also have account minimums as well. Because there is significant variance on this, be sure to read the fine print.

HISAs appear to have lost a significant degree of popularity in recent years - mainly due to the advent of the online account. For small amounts, the interest earned doesn't appear to reward the onerous bonus interest requirements by comparison with online acounts.

4. Cash management accounts (CMAs)

Cash management accounts evolved as an all-in-one solution designed to take care of large amounts of cash with higher interest but a full range of access, i.e. ATM, EFTPOS, internet, phone and cheque.

Normally, CMAs can have higher fees applying to them if their balances fall below a certain amount. Also, they usually only pay interest above certain balances. But this (interest) is usually quite high compared to transaction accounts.

CMAs have also been losing popularity in recent years as people realise that using a combination of a transaction account and an online account yields similar levels of convenience with minimal extra disruption.

Banks appear to be realising this, and some have started issuing more sophisticated CMAs that are targetting this market - these CMAs are probably more accurately termed online accounts with better access functionality. However, it remains to be seen whether these enhanced CMAs are successful.

5. Cash management trusts (CMTs)

A bit of a red herring - these are not bank accounts at all, but a special kind of managed fund that only invests in cash assets.

But given that most of them these days appear to have enhanced access facilities such as ATM, EFTPOS, internet, phone and cheque, and pay market rates of interest in arrears, quite a lot of CMT users use them in place of CMAs.

Be aware that fees are usually implied rather than explicitly charged, and that significant minimum balances are normally required. Also, like all managed funds, none of them come with a bank guarantee.

6. 24 hour accounts & 11AM accounts

These are extremely sophisticated bank accounts for people who need to have extremely large amounts of cash on hand at short notice.

They normally don't have any access methods, save for credit to and debit from a nominated account, however, they do pay top rates of interest and they generally have multiple storage facilities within the account - for example, you can generally designate a portion of the funds invested to be locked away in several term deposits within the account as well as having cash on call - as well as sweep facilities and consolidated reporting.

Seriously high minimums apply with these, and most retail investors will never require use of these.

7. Online accounts

These were the banking innovation of the 1990s. Basically, these pay a high rate of interest on all funds invested, and normally charge no account keeping or transaction fees.

This blogger regularly used to breathe sighs of sheer amazement as these accounts brazenly fought it out for market share with interest rates that were regularly over and above the official cash rate set by the Reserve Bank.

The catch is that you need to have a nominated account (normally a transaction account) set up for credits into and debits out of the online account, but with the advent of enhanced CMAs, this could be coming to an end.

It's also notable that some online accounts are getting more sophisticated themselves. This blogger saw one offered by a credit union that offered multiple storage facilities, much like in a 24 hour account. Unfortunately, some of the attraction of these accounts is in their simplicity - so it remains to be seen if this kind of innovation is successful.

Banks offer plenty of other types of deposit accounts as well, these are just the main ones. Others that you might come across are childrens' accounts, pensioner (deeming) accounts, Retirement Savings Accounts (RSAs) and others.

Also, we've really only looked at accounts for personal use - there are plenty for business use as well.

In my next post, I plan to tackle fees, although I might switch order yet again and put my case study in. Or do cheques.

Dikkii's financial tips index

Standard but necessary disclaimer: This is not advice. Only a complete idiot would think that any of this constituted advice. It's not even vaguely reasonable to consider this to be advice. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.


Plonka said...

Looks like I have some catching up to do.

I've moved Dikkii (it's Ted, BTW). Could you update you link please? I'll get to some more meaningful (or not) comments tomorrow...

Dikkii said...

Hi Ted,

I'll get your blog link updated in a few moments.

Some nice work, there too, by the way.

beepbeepitsme said...

I thought I left a comment here. Maybe blogger ate it.. :(

Dikkii said...

Hi Beep.

Blogger's been doing some funny things at the moment to me, so it wouldn't surprise me.

However, this might be the comment that you're after:

Click here.

Plonka said...

Excellent stuff as usual Dikkii.

You know, I spent two years a while back ('97 - '99) working for Mercury Asset Management and was there when they merged with (got bought by) Merrill Lynch (in IT, not finance)and I'd never heard of 24hr and 11am accounts.

My ignorance of all things financial never ceases to amaze me...:)

Dikkii said...

Given the large amounts of cash that Merrills/Mercury would have been moving around, it would be surprising if they didn't have a 24 hour or an 11 AM account.

Some banks call them a Cash Deposit Account - that ring any bells?

Plonka said...

Not even remotely. Ignorance is bliss...:)

beepbeepitsme said...

Oh yeah - that was the comment. lol

Oh well, I am slowly going towards the anciently forgetful. Damn. Now that's a pisser.