Dear Dr. Don,
I have $85,000 in a money market account paying a money market rate of 2.62 percent. Should I take a portion, about $40,000, and put it in a CD for five years paying 5 percent while leaving $45,000 in the money market account?
— Mary Mingle
There are a lot of unanswered questions that spring from your question. How much of your wealth does this represent? Are you retired? What role do you want this money to play in financing your life goals?
Typically, investors deciding between a money market account and CDs have safety of principal as their chief investment goal. However, remember that inflation can erode the purchasing power of that principal. That is usually the biggest risk in investing in money market accounts, since an FDIC-insured money market account eliminates the risk of not getting your principal back.
A money market account provides liquidity that the CD (with its early withdrawal penalty) doesn’t. However, in some cases, you may come out ahead with the CD, even if you have to pay a penalty for early withdrawal. Check your bank’s CD rates and penalty provisions to find out if this is the case. If so, you could allocate more money to CDs than your proposed split.
Although the survey data is about 2 years old, the Bankrate feature “CD early withdrawal penalties survey” provides a nice framework for you to see the tradeoffs between the liquidity of a money market account and the higher yield of a CD.
Investing more money in CDs doesn’t make sense if you plan to keep the $45,000 in the money market account to meet short-term spending needs over the near term. In that case, your plan of splitting the $85,000 between liquidity and savings is sound.
Of course, you’ll want to shop rates for both types of accounts using Bankrate’s “Compare Interest Rates” page.
You could also build a CD ladder that spreads the longer-term money across maturities. That reduces the chance that you lock into long-term savings only to see interest rates head higher — which is known as “being long — and wrong.” The Bankrate feature
“How to ladder a CD portfolio” explains the hows and whys of CD laddering.
Finally, if you’re ready to take a big-picture view of your investments and life goals, consider working with a financial planning professional. I recommend a fee-only financial planner for people who are new to financial planning.
The National Association of Personal Financial Advisors can help you find a fee-based planner in your area. Bankrate can also help you find a Certified Financial Planner.