Consider this: You’ve got a good job and a steady paycheck, and you’re happy with your checking account. Now, you’ve got to decide what to do as you build up your savings. Stash all that money in a savings account? Or open up one or more certificates of deposit (CDs) where the money will be locked away for a period of time but could potentially earn more interest?
Read on, and we’ll help you figure out the right move for your situation and goals.
How do CDs and savings accounts differ?
Both of these deposit account types are available from a wide range of banks and credit unions.
If you have a stash of cash that you know you won’t need to touch for a designated period of time, a certificate of deposit, or CD, is a low-risk option for storing those funds and earning interest. The reason it’s comparatively low risk is that the annual percentage yield (APY) will not change throughout the term of the CD, which can typically range from three months to 10 years.
Savings accounts offer more flexibility than CDs, as most will allow you to make six withdrawals per statement cycle (this varies by institution) without penalty.
By contrast, if you withdraw funds early from a CD, the early withdrawal penalty generally means you’ll forfeit the interest and potentially lose some of the principal as well.
A savings account might earn an APY on par with some CDs or one that’s much lower depending on what type of savings account you have. Traditional savings accounts at brick-and-mortar banks may have lower APYs, while high-yield savings accounts offered by online banks might feature higher rates.
We’ll explain more details you should know about CDs and savings accounts in the following sections.
Pros and cons of CDs
One of the main benefits of a CD is that you’re guaranteed a certain APY for the length of the CD term. By contrast, financial institutions can change the APY on a savings account at any time—though such changes often coincide with the Federal Reserve raising or cutting the federal funds rate.
But, CDs are not ideal for uses like an emergency fund or a down payment when you intend to buy a house very soon, as you need to be able to access your money quickly in those situations. If you decide to invest in CDs, you’ll want to have a concrete plan to ensure you aren’t overextending yourself.
Pros
- CDs typically have a higher APY than a traditional savings account.
- APYs are locked in regardless of external market factors.
- There are numerous CD term lengths, such as three months, six months, one year, five years, and 10 years, suiting a variety of financial goals.
Cons
- You’ll likely pay a severe penalty if you make an early withdrawal.
- Returns typically not as high as one might get by investing in stocks, bonds, or index funds.
- Funds are locked in for full term length, meaning less accessibility and liquidity.
Pros and cons of savings accounts
Savings accounts are a common vehicle for storing funds beyond what you need to pay your bills and day-to-day expenses because they offer flexibility. It’s easy to set up recurring deposits, for example, and one can avoid withdrawal penalties by minding the bank or credit union’s restrictions on number of withdrawals per month (if any).
There used to be a federal cap of six withdrawals per statement period from savings accounts, but the Federal Reserve removed that in 2020. Some institutions still enforce the cap by their own choice, however.
As mentioned earlier, some savings accounts offer an APY that’s a pittance compared to CDs (with the national average rate being just 0.41% as of this writing) while others offer APYs that actually compete with CD offerings, approaching 5% in some cases. You’ll typically need to seek out a high-yield savings account to get such a rate. But, know that your bank or credit union can increase or reduce the APY of your savings account at any time.
We recommend high-yield savings accounts for money that you want to earn interest on while keeping relatively liquid. They’re ideal for financial needs and goals like building an emergency fund to cover three to six months of expenses, growing your down payment as you house shop, and saving for an upcoming vacation.
Pros
- Easier access to funds in case of emergency or to make a big purchase.
- Money typically earns interest, especially with high-yield savings accounts.
- Often have low or no minimum deposit requirements to open.
- Some institutions offer bonuses for new customers.
Cons
- May have a minimum balance to qualify for the highest APY.
- Rates may not be as high as some other savings/investment vehicles.
- Your financial institution can change the APY at their discretion.
- Many banks still enforce a cap of six withdrawals per statement cycle.
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How to choose between a CD and a savings account
If you’re not sure which account type is right for you, consider these three questions:
- What are you trying to accomplish? For those looking to save up money to make a specific purchase such as a new car or other big-ticket item, a CD could help you have a concrete timeline of how much money to put in and when those funds will be available. But, if the goal is more to build up a pile of money in case of an emergency, available to spend with minimal delay, a savings account is the better move.
- How much do you have available to put into your deposit account? Depending on the institution you’re banking with, there can be a litany of requirements to maximize bonus offers and rate potential with a savings account. On the other hand, you typically can’t add money to a CD after you’ve opened it. If your plan involves starting off with a lower balance and adding money over time, a high-yield savings account offers the flexibility to do that
- How might potential penalties affect you? If you’re using a CD, that means you should essentially consider access to those funds off the table until the term length reaches maturity. There are potentially steep penalty fees for early withdrawal, so if the funds might be needed in case of an emergency or other situation, it’s best to opt for a savings account so you have more liquidity.
The takeaway
It’s important to remember that having both types of accounts is a viable option if that’s what makes the most sense for your financial situation and you have enough to deposit in both. For people planning for a mix of short-term and long-term goals, using a savings account to cover short-term goals or emergencies and a CD to supercharge savings goals that are further down the line could be the best of both worlds.
Frequently asked questions
Can I get a savings account APY of 5%?
At the time of this writing, there are high-yield savings accounts on the market offering up to 5% APY. That could change if the Fed cuts the federal funds rate later in the year and banks and credit unions reduce the rates they offer customers in response.
How high a rate can I get with a CD?
You may be able to find CD rates up to 4.50% APY at the time of writing. While that’s a little lower than you might find with top savings accounts, remember that a CD protects your APY for a period of several months or even several years.
When should I consider a money market account?
A money market account, or MMA, can be thought of as a hybrid between checking and savings. It will typically offer a higher APY than you’d get with checking and more flexibility to access your funds than a savings account—for example, the ability to write checks from the account. However, there may be minimum balance requirements, so MMAs are generally best for those with enough cash to avoid potential monthly fees and meet any APY tiers.