Making the decision to commit to a savings plan is a great step toward building a bright financial future. Once you’ve decided to move forward with your savings goals, it’s time to choose where you want to stash this cash.
Luckily, there are several useful options available to save for long-term goals like buying a house and short-term goals like funding your next vacation. Both certificates of deposit (CDs) and savings accounts offer a safe place to store your funds until you need it. But they both come with pros and cons. Understanding the differences can help you determine what the best option is for your goals.
Let’s take a closer look at the differences between CDs and savings accounts.
What is a certificate of deposit?
A CD is a type of savings vehicle that you’ll find available at most financial institutions. When you open a CD, you’re choosing to lock up your deposit at the bank and forgo any access to these funds for the specified term. CD term lengths can range from a few months to several years. If you want to withdraw your funds before the CD reaches maturity, you’ll likely have to pay a penalty. That’s why it’s important to make sure that you won’t need the funds throughout the CD term before buying one.
Generally, you’ll earn a guaranteed rate of return when you open a CD.
You can ensure that your deposit is safe and won’t lose any principal by seeking out Federal Deposit Insurance Corp. banks and National Credit Union Administration credit unions. These entities will protect up to $250,000 per depositor, per institution, per ownership category.
What is a savings account?
A savings account is a standard type of account offered by banks and credit unions. These accounts are also federally insured up to $250,000, making them an equally safe place to stash your cash.
When you open a savings account, you’ll usually be able to do so with very little cash upfront. But the minimum deposit you’ll need to open an account varies from bank to bank. Once the account has been opened, you’ll have quick access to your funds whenever you need it. However, there are some limitations on how often you can move funds out of your savings account. You’ll generally only be able to make six transfers or withdrawals from your savings account per statement cycle. There are exceptions.
Although some savings accounts offer a competitive APY, not all do. If you’re looking to earn a better return on your savings, then consider a high-yield savings account. With that option, you’ll still be able to get access to your money six times per month but with a better rate of return.
When to use a CD versus a savings account
A CD is a low-risk option that can provide a solid boost to your savings. The guaranteed fixed rate of return can be an attractive feature for many savers. You’ll know exactly what you’ll be earning on your savings for a specific term, whether it’s six months or five years.
With this structured savings plan, you can save for longer-term goals. For example, let’s say you want to buy a house in five years and plan to put down a sizable down payment. You can stash your funds in a five-year CD for a guaranteed return on those funds. At the end of the term, you can use the money plus the interest it earned as a part of your down payment.
CDs are also a good option if you’re one of those people with a habit of raiding your savings. Although true emergencies will happen, some of us struggle to leave our savings untouched in a standard savings account that won’t penalize you for withdrawing the funds whenever you’d like.
When to use a savings account versus a CD
The main reason to use a savings account is the promise of unfettered liquidity. You’ll have access to the money in a savings account pretty much whenever you need it.
With this fast access to cash, a savings account can be a good spot to stash money earmarked for your emergency fund. If you need the funds at any time, you’ll be able to access them without paying a penalty. Another good use of a savings account is to make progress toward short-term savings goals. If you want to save for your holiday shopping or an upcoming vacation, a savings account is a great choice.
However, the tradeoff is that you could be passing up the opportunity to earn a higher interest rate with a CD. You’ll have to decide which savings vehicle is the best fit for your savings goals.
The choice between a CD and a savings account will be clear based on your current savings goals. If you want quick access to these savings for a short-term goal, then a savings account is the way to go. If you want to maximize your APY for a long-term goal, then a CD might be a better fit.
In either case, make sure to shop around for the best interest rates for both CDs and savings accounts before making a final decision. Move forward once you are clear on the goals you have for your savings.
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