Where to park your hard earned cash requires you to make an investment decision. The best vehicle for you is based on how much access you need to your money and your longer-term goals. Savings accounts are flexible, but offer very little return on your investment. Certificates of deposit (CDs) pay higher interest rates, but lock in your money for a predetermined period of time.
Similarities between CDs and Savings Accounts
Certificates of deposit and savings accounts both allow you to save your money without risk to your principal. In other words, a dollar today is a dollar tomorrow and does not gain or lose value. Most CDs and savings accounts are offered through banks and are FDIC insured, which means that the U.S. government insures your deposits if the bank fails.
How CDs and Savings Accounts Differ
The biggest difference between a savings account and a certificate of deposit is access. A CD commits your money for a certain length of time. It could be as little as six months or as much as five years, or anything in between, but in any case, you are guaranteed the stipulated interest rate for the entire time. If you withdraw your money early, you will have to pay a penalty, typically a forfeit of all interest earned. Savings accounts let you add and withdraw money as you wish, but interest rates continually fluctuate.
Benefits of a CD
CDs offer higher interest rates than savings accounts and the rates are locked in for the entire term of the certificate. The longer the time horizon, the greater the interest rate you will be paid. So if you are saving for a house down payment or a new car and you know you will not make the purchase for another two years, you can take advantage of a longer term CD with a higher rate. CDs require a minimum investment, usually around $1,000, and often pay higher interest for larger amounts.
Benefits of a Savings Account
Savings accounts pay a very low interest rate, and rates go up and down on a regular basis. However, the minimum investment is a small amount -- usually less than $100. You can add new money and make withdrawals at your leisure. Savings accounts can be linked to checking accounts and transfers can be made between them. Many employers allow direct deposit into a savings account and you can pay many bills through direct withdrawals from a savings account.
Your Goals for Your Money
If you are saving towards a specific purchase, such as a new car or a down payment on a house, a CD will provide a higher interest rate if you know you will not need to access the funds during the term of the certificate. A CD is also a reliable place to stash a portion of your emergency money. Savings accounts are probably your best option if you want to be able to withdraw funds or move around your money at any time. You may find that you want to put a percentage of your money into a CD and keep the rest in a savings account.
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