Are you saving up for something fun, like a new car, a gourmet kitchen or a vacation?
Short-term goals like these can be great, but where’s the best place to stash that money? The stock market is too volatile for savings goals of fewer than a couple of years, and forget about winning big in the cryptocurrency casino.
CDs and savings accounts: An overview
Savings accounts are the most basic type of account. You deposit money in a bank and earn a small amount of interest in return. Money market accounts are similar, but can require larger minimum deposits and sometimes pay more interest.
A CD is like a bond: You are essentially loaning the bank a specific amount of money—say $1,000—for a set period of time, which could vary from three months to ten years. At the end of that period, the CD has matured, and the bank pays you back your money and interest. The longer you agree to tie up your money, the more interest you make, but withdrawing your cash before the maturation date will incur penalties.
Both CDs and savings accounts can be opened at just about any bank, whether local or online.
Which is the best choice?
Savings accounts are more flexible; you can deposit or withdraw at any time, with no penalties. They’re best if you want to build your savings with money from every paycheck, or if you aren’t sure when you’ll need the cash. For example, a savings account is preferable for your emergency fund, which covers unforeseen expenses like a big car repair.
By contrast, CDs are not liquid; in most cases, once you buy the certificate, your money is locked in for a set time period. That can be good if your savings goal is very specific. For example, if you want to buy a new car in three years, a three-year CD might be a good way to save for it. Note that you can’t add money to an existing CD, but you can open as many as you need.
The catch to savings accounts is low interest—currently the best nationally available savings account pays 1.6 percent APY. By contrast, the best nationally available 1-year CDs now pays 2.1 percent APY, while the best nationally available 3-year CD pays 2.4 percent APY. That difference can add up: A CD could earn you nearly $1,000 more in interest on a $10,000 deposit over five years.
Interest rate risks
Both CDs and savings accounts are insured by the Federal Deposit Insurance Corporation up to $250,000, so they’re equally safe; you can’t lose your money if the bank fails. However, both come with their own versions of interest rate risk.
With a savings account, the bank can change its interest rate at any time, even without notice. Of course, if your rate drops you are free to withdraw your money and find a better deal at another bank. With a CD, your interest rate is guaranteed over the term of the certificate. So if interest rates drop, you’re in luck. On the other hand, if rates go up, you’re stuck with what the rate you have.
Mixing your options
An alternative to the either/or approach is to open a savings account and fund it every month; when you hit a certain amount (say $1,000), you can transfer the balance into a CD. You can also buy multiple CDs with different maturation dates—a strategy called laddering—that gives you the benefits of CD interest rates without tying up all your money for a long time.