Evaluating a CD versus a Savings Account
When should you choose a certificate of deposit, known as a CD, versus a savings account? It's a common question for anyone who wants to save money, but the correct choice ultimately depends on why you're saving and when you want to be able to tap into your cash. Here's a closer look at what you can expect from a CD versus a savings account to help you develop a financial strategy that's tailored to your lifestyle.
What's a savings account?
A savings account allows you to deposit your funds using a variety of methods, which may include direct contributions from your paycheck, transferring funds from another account, or making a deposit using the branch, an ATM or a mobile app.
Most savings accounts allow you to withdraw your money when you want without penalty. However, some may charge service fees or require you to maintain a minimum balance in order to avoid fees. Understanding the terms of any account before you open can help prevent you from unintentionally losing money you could otherwise save.
What's a certificate of deposit?
A certificate of deposit, or CD, is a type of deposit product that offers a specific interest rate for holding money until a certain date when the CD has matured. The saver can then withdraw the funds originally deposited in the CD, plus the interest earned, without penalty. If the saver needs to access the funds in the CD before the maturity date, an early withdrawal penalty could apply.
The interest rate that a CD pays depends on a number of factors. This includes the financial institution issuing the CD, the amount of money deposited in it and the amount of time the saver agrees to keep the money in it (also known as its term). Generally, CDs with terms that span several years will pay more than those with terms that last less than one year.
What's the difference between a CD and high-yield savings?
The term high-yield indicates the savings account pays a competitive interest rate on funds deposited. In today's historically low interest rate environment, for example, the average savings account interest rate in the United States is about 0.05%. A high-yield savings account, on the other hand, might offer an interest rate of about 1%. Savers with a high-yield savings account will likely be able to withdraw funds anytime, without penalty, but the interest rate is subject to change at any time. Though savers with money in a CD may not be able to access their money penalty-free at any time, their CD may include a fixed rate that doesn't change until the CD matures.
While there isn't a significant difference in today's interest rate environment between some CDs and high-yield savings accounts interest rates, that's not always the case. In mid-2006, for example, some shorter-term CDs paid more than 5% interest compared to high-yield savings accounts, which generally paid about 4% interest.
Now that you know the difference between a CD and a savings account, consider how both products might help support your different financial goals.
Consider a CD if:
- You're certain that you won't need to access your savings for a specific period of time.
- You want to ensure you won't be tempted to tap into your savings every now and then.
- You want to earn more interest than a high-yield savings account offers, and you have a target time frame when you want to have the cash available.
Consider a savings account if:
- You're trying to build a rainy day fund and want easy access to your cash in case you need it.
- You want to be able to tap into some of your savings through an ATM or funds transfer on occasion.
- You want to be able to easily move money between your checking, savings and other financial accounts.
- You like to be able to see your savings grow each week or month, as you make recurring contributions and earn interest.
CDs and savings accounts have similarities and differences, and both can be used jointly as part of a larger strategy. Work with your banker to develop a portfolio of savings products that support your short- and long-term financial goals.
