If you want to invest your money in an interest-bearing account with virtually no risk of losing your principal, you might choose a certificate of deposit or a savings account. Both are common savings tools offered by most financial institutions and both are safe and easy to open.
Some key differences exist, however, between CDs and savings accounts, and they’re designed for people with different needs. Delve into the differences between these accounts and decide which account is best for your savings goals.
What Is a Savings Account?
A savings account is a deposit account that earns interest. Just about anyone can open one — and some savings accounts don’t require minimum opening deposits. Although you can’t write checks against your balance like you can with a checking account, you can access your money at ATMs using a debit card.
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Unlike CDs, savings accounts enable you to withdraw your money at any time but they generally come with slightly lower interest rates. Savings accounts are excellent vehicles for emergency funds if you don’t need the money right now but want to be able to access it quickly — without paying a penalty — if something comes up.
Interest rates vary among financial institutions so it pays to shop around for the best savings account. All savings accounts, however, have four things in common:
- They don’t have maturity dates.
- You earn interest on your balance.
- Withdrawals and deposits are allowable.
- By federal law you are limited to six transfers — including electronic and telephone but not ATM withdrawals — per statement cycle.
An online savings account will typically offer higher savings interest rates than a brick-and-mortar bank. Online banks have lower overhead costs than traditional financial institutions and they typically pass those savings on to their customers.
What Is a Certificate of Deposit?
A CD is a time deposit account, which means you can’t withdraw your funds for a set time period without paying a penalty. The trade-off for not having access to your money is that the CD rates and APY are generally better than even high-yield savings account rates.
The longer you’re willing to commit your money to a CD, the higher interest rate you’ll get. CDs can have maturity periods ranging from three months to 20 years.
CD interest rates used to be so high you could easily retire on just your account’s interest. In 1981, for example, a six-month CD came with an interest rate of 17.98 percent.
Say you were 25 and bought a $10,000 CD that year — if you rolled it over every year until you turned 65, it would have been worth $13 million. Those days are long gone, so today’s CD investors have to develop new strategies, like the CD ladder.
The CD Ladder Strategy
CD ladder strategies are designed to help investors balance their hunger for higher rates with their need to access their cash. For example, one-year CD rates are lower than two-year CD rates, but you might not want to tie up your money for two years.
Enter the CD ladder strategy. You could split the money you want to invest into four and stagger your investment across several CDs, which gives you periodic access to funds. If you wanted to invest $2,000, your CD ladder strategy might look like this:
- $500 in a six-month CD at a rate of 0.41 percent
- $500 in a one-year CD at a rate of 1.39 percent
- $500 in an 18-month CD at a rate of 1.44 percent
- $500 in a two-year CD at a rate of 1.64 percent
How to Decide Between These Savings Options
Both CDs and savings accounts are safe, FDIC-insured instruments you can use to preserve your principal and earn some interest. A CD a good choice if you don’t think you’ll need to access your money until it matures. A savings account is more flexible but generally comes with a lower interest rate. Choosing one or both options might be the right move for you.
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