Savings accounts and certificates of deposit (CDs) keep your money safe and pay interest. They are an excellent option for money you may need to spend in the next few years, but they have different features you should be aware of. Differences between the two include interest rates and the ability to access the money without penalty.
What is the difference between savings accounts and certificates of deposit?
Savings Account Certificate of Deposit
Flexibility
Savings accounts are more flexible than certificates of deposit. You can withdraw money without penalty at any time, and you can continuously deposit money into the savings account. However, this doesn’t mean you should rule out certificates of deposit.
Certificates of deposit are ideal for money you need at a specific future date. For example, if you know you’ll be paying tuition in 19 months, an 18-month CD could maximize your interest earnings. Additionally, if you have extra cash you want to keep safe, with no intention of spending the money soon, a CD may be beneficial.
Generally, you can withdraw a CD early, which may be necessary if you need emergency cash beyond what you have in your rainy-day fund. If you withdraw money from a CD early, you will usually incur early withdrawal penalties, which can erase any interest you earn and affect the original deposit. Some CDs, known as liquid CDs, allow for early withdrawals, but make sure to understand the details before using those instruments.
Savings accounts are ideal for cash that you may need to access at any time and for money you plan to spend in the next six months or so. For example, a savings account is an excellent place for a small emergency fund or a cash cushion that you transfer to your checking account to avoid overdrafts.
Savings accounts allow you to deposit and withdraw funds with minimal restrictions. In April 2020, the Federal Reserve amended Regulation D by eliminating the six-per-month limit on convenient transfers from “savings deposits.” They are user-friendly and easy to understand.
Interest Rates
Certificates of deposit are time deposits that require you to commit to leaving your money in the account for a specified period. For example, you can purchase CDs for terms ranging from three months to five years. In return, the bank or credit union offers you higher interest rates the longer you commit.
CDs provide a guaranteed interest rate that typically does not change. If you think interest rates will rise soon, a savings account may be the better option. However, if you are satisfied with the interest rate on the CD and are willing to lock away your money, the CD can perform well.
With a CD, you can predict exactly how much you will earn. Most banks set your rate at the beginning of the term, and that rate never changes. This works in your favor if interest rates remain the same or decrease, but you could miss out on additional earnings if rates rise significantly.
Banks typically pay higher interest rates on CDs compared to savings accounts. This is especially true when you choose longer terms (a two-year CD should pay more than a three-month CD). All else being equal, interest rates tend to be higher on CDs vs. savings accounts.
Unlike CDs, savings accounts have interest rates that may fluctuate over time. Banks adjust the interest rates of savings accounts based on the economic environment, competition, and their desire to attract funds in the form of deposits. If rates are rising, your savings account may pay more next month than it does now (although banks are slow to raise rates). But if rates sharply decline, banks typically respond by paying less, while your earnings will not change if you are locked into a CD.
Limit
The minimum money required to open an account
Savings accounts allow you to start with a small amount, so they work well when you have limited funds. After that, there is no problem keeping large balances in savings accounts, as long as you do it intentionally. On the other hand, certificates of deposit may have some minimum deposit requirements. Traditional banks may require you to invest at least $1,000, but there are many online banks that offer certificates of deposit with no minimum initial deposit.
A choice that combines the best of both worlds
Fortunately, you don’t have to choose between certificates of deposit and savings accounts. You can use both, and other alternatives may also meet your needs.
Keep enough cash in the savings account to meet any short-term needs. You will have easy access to that money, and you won’t face penalties if you need to make withdrawals regularly. Consider using certificates of deposit for some excess cash if you have enough cash in your savings account, love the interest rates on CDs, and aren’t worried about rising prices. Look for other alternatives if certificates of deposit are too harsh for your taste but savings accounts don’t pay enough. Money Market accounts have features of both CDs and savings accounts, but they often pay a little more than standard savings accounts. Cash Management accounts may also offer higher yields. Just make sure your money is insured by the FDIC if safety is important to you (NCUSIF insurance in credit unions is also perfectly safe).
Conclusion
If you know you’ll need access to your money in less than a year, a savings account may be your best option. Savings accounts are also ideal if you’re just starting to save money and only have a small amount to begin with. Interest rates on savings accounts are very low, but if you search well, you can find high-yield savings accounts.
If you want to earn a higher interest rate and can part with your money for at least a year, a certificate of deposit is a good option. You will need at least $1,000 to open an account. CDs work well if you already have enough money in savings accounts to cover emergencies.
Certificates of deposit and savings accounts each have their own advantages, but you don’t have to choose between them. You can use both and explore other alternatives that may meet your financial needs.
Source: https://www.thebalancemoney.com/cd-vs-savings-account-pros-and-cons-4176848
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