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If you’re looking for a safe place to stash your cash and earn some interest, it’s hard to go wrong with a certificate of deposit or a savings account. Understanding the differences between these two deposit accounts can help you determine which one is the better choice for your goals.
Let’s take a closer look at the differences between CDs and savings accounts.
CDs (certificates of deposit)
Certificates of deposit are safe places to save money, especially in times of economic uncertainty. Unlike stocks, bonds and other assets that fluctuate in value, CDs provide a reliable rate of return.
They are a good product for savers who don’t like risk or are at a stage of life when investing in more volatile assets is not the best course. They’re also useful for savers who have specific goals, such as buying a house or auto, or paying for a wedding or vacation.
What is a CD?
A certificate of deposit (CD) is a type of savings account that requires the account holder to leave their money in the account for a specified amount of time, known as the CD “term,” in exchange for earning a fixed rate of interest.
If you open the account online at the bank’s website, you likely will need to electronically transfer money from another bank account, so have that account information ready.
How do CDs work?
CDs generally pay more interest than traditional savings accounts and the annual percentage yield (APY) is fixed. In a rising-rate environment, it’s smart to build a CD ladder so that all your money isn’t locked up at a lower rate as yields rise.
Opening a CD account usually requires a minimum deposit. Some banks don’t require a minimum deposit, but most institutions do. They can range from $50 to $1,000 or more. Once a traditional CD is opened and funded, the depositor cannot add money to the account during the term.
CD term lengths generally range from a few months to five years. If you withdraw your funds before the CD reaches maturity, you will pay a penalty that could put a significant dent in your interest earnings.
Traditional CDs are common, but there are other types of CDs. Among them are: bump-up, no-penalty, jumbo and IRA CDs.
Look for banks insured by the Federal Deposit Insurance Corp. (FDIC) and credit unions insured by the National Credit Union Share Insurance Fund (NCUSIF). This coverage will protect up to $250,000 per depositor, per insured institution, per ownership category.
When should you choose a CD instead of a savings account?
A CD is a low-risk option that can provide a solid boost to your savings. The fixed rate of return is an attractive feature for many savers. You can know exactly how much interest you will earn on your savings during the term, whether it’s six months or five years.
A CD is a good savings tool for medium-term goals. Let’s say you want to buy a car in three years and make a big down payment. You can open a three-year CD for a guaranteed return. At the end of the term, you can put your principal investment, plus the interest it earned, toward your down payment.
CDs are better when you know that you will not need the funds for a certain period of time.
Savings accounts are also safe places to stash cash and grow your money. Unlike CDs, however, yields on traditional savings accounts are variable rather than fixed. They can move up and down.
Yields on savings have been going up since the Federal Reserve began aggressively raising its benchmark interest rate this year.
Online banks typically pay higher yields because they have less overhead than branch banks.
What is a savings account?
A savings account is a standard product offered by banks and credit unions. It typically pays interest, allowing you to earn a return on your savings.
Online banks have much lower overhead costs than brick-and-mortar banks, so they can offer more competitive yields on their deposit products. It’s good to find a high-yield savings account that pays an above-average APY.
How does a savings account work?
Opening a savings account is likely to require very little cash upfront. The minimum deposit to open an account varies from bank to bank, and some accounts have no minimum at all.
Once the account is open, you will have easy access to your money when you need it. Unlike a CD, a savings account doesn’t require you to lock up your money for a set period of time.
However, there may be limitations on withdrawals. You’ll generally be able to make up to six transfers or withdrawals from your savings account per statement cycle. Depending on its policy, your bank might close your savings account or convert it to a checking account if you exceed the withdrawal limit.
You can add money to a savings account whenever you want. Some savers set up automatic withdrawals from their paycheck that go directly into a savings account.
Some savings accounts charge a monthly maintenance fee unless you maintain a certain balance.
When should you choose a savings account instead of a CD?
Use a savings account instead of a CD if you need regular access to the money. With a CD, you won’t be able to withdraw the funds before the account’s maturity date without paying a penalty. With a savings account, you have access to the money pretty much whenever you want, though you’ll generally be limited to six withdrawals per month.
The immediate access to cash makes a savings account a good spot for an emergency fund. Another good use of a savings account is to save for short-term goals. If you want to save money for holiday shopping or a vacation, a savings account is a great choice.
The trade-off 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 goals.
Yields on savings are on the rise, so it’s a great time to get into the habit of socking away money.
Depending on the institution you choose, savings accounts and CDs can be opened at a branch or online through your bank’s website. Just be sure you go with a federally insured bank or credit union.