You’ve got a wad of cash saved up and rather than risk the temptation of blowing it all on a ridiculously expensive new car you don’t really need or lavish vacation you’ll later regret taking, you’re thinking it would be wiser to invest the money and grow your savings. Money markets and certificates of deposit, or CDs, are two of many investment options available. Understanding the differences between the two will help you decide which is best for you.
Before you can choose whether to bury your money in a CD or a money market you probably want to know how each works. A CD is like a savings account in which you invest a certain amount of money for a specific amount of time. The bank that issues the CD agrees to pay a specific fixed interest rate during the term of the investment and when it reaches maturity, the issuing bank will pay you the principal investment plus interest. A money market works like a low-risk version of a mutual fund. An investment firm pools money from various investors and then invests it in low-risk securities including CDs and government securities.
The common thread between CDs and money market funds is that they are generally considered safer ways to invest than more unpredictable investments like stocks and mutual funds. While both options share the benefit of security, they also share the drawback of low returns. Riskier investments also offer higher returns, so don’t expect exponential returns with either a CD or money market.
Access to Cash
Consider how long you can go without your money before deciding between a CD and money market. CDs require you to leave your investment alone until it reaches maturity or risk paying a penalty or forfeiting your return for early withdrawal. This means if you invest your $10,000 in a five-year CD, make sure you won’t need to access it during that time. With money markets, on the other hand, you can access your money any time.
Fixed vs. Variable
Most CDs are purchased at a fixed interest rate. In other words, if you invest your money in a five-year CD with 1.5 percent interest rate and the rate increases a year after you purchase it, you’ll lose out because you’re locked in at the lower rate. While you can’t access your CD, most banks maintain a “call” clause, which grants them the ability to terminate your CD if rates drop.
Money markets offer variable interest rates and the accessibility to move your money around. The money you put into a money market gets invested in different low-risk securities with variable interest rates, which means you’ll rake it in when rates are up, but you could also lose out if rates decrease.
- money image by Bradlee Mauer from Fotolia.com
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- What Is the Difference Between a Money Market Fund & a Certificate of Deposit?
- Disadvantages of a Structured CD Investment