You’ve managed to avoid the shoe department, you took a “stay-cation” in your backyard this year instead of sipping drinks poolside in the Caribbean, and you decided to keep your car a few more years now that it’s paid off. Take the thousands of dollars you saved, and invest it in a money market account or a certificate of deposit.
Money Market Account
A money market account is a savings account available at banks and credit unions. They are insured by the Federal Deposit Insurance Corporation, or by the National Credit Union Administration, for up to $250,000 per depositor, per financial institution. Money market accounts typically require a higher minimum balance than a regular savings account and have certain restrictions. For instance, you can’t make more than six withdrawals a month, and you can only write three checks per month. But, you usually earn more interest on a money market account than you would on a regular savings account.
Certificate of Deposit (CD)
A certificate of deposit is a deposit account available at banks and credit unions. CDs are also insured by the FDIC or the NCUA for up to $250,000. Like money market accounts, CDs offer a higher interest rate than a regular savings account does. CDs differ from money market accounts in that you deposit a set amount of money for a specified period -- typically for six months, one year, five years or more. The issuing bank pays you interest at regular intervals. When you cash in your CD, you get your original investment plus any accrued interest. You can get a CD through a brokerage firm, too. Deposit brokers -- who work at stock brokerage firms or firms that specialize in selling CDs -- might be able to get you a higher rate on your CD by promising to bring a certain number of deposits to a financial institution, according to the FDIC.
The way you decide between a money market and a CD depends on how liquid you need your money to be. With a CD, you are locked in to the term of the CD. If you withdraw the money before the CD is scheduled to mature, you pay a penalty. A money market account is liquid, unless you have exceeded your withdrawal limit. Because you have greater access to your funds with a money market account, you typically earn less interest that you would from a CD. However, if you lock in to a low fixed rate on a CD, your money market account could pay more interest if the interest rates rise. According to Bankrate.com, when making a decision, you shouldn’t invest long-term when you think you might need money in the short-term, and vice versa. You shouldn’t invest short-term when you won’t need the money for awhile.
The interest rate on a money market account is variable, meaning it can go up or down. If the interest rates go up, you could earn more money with your money market account than on a fixed rate CD. Typically, CDs have a fixed rate, but you can also get a variable rate CD. Investors might want a variable rate CD if the interest rates are low. You can typically get a better rate on a variable rate CD than you can with a money market account, according to the Northbrook Bank and Trust Company. You have to be a little more careful with a CD than with a money market account. The FDIC points out that if you fail to cash in your CD when it matures, it might automatically renew, tying up your money all over again.
If you go the CD route, you can try the laddering technique to increase your liquidity and to guard against being locked in to a low interest rate. You can get locked in if you invest in a long-term, fixed-rate CD and the interest rates go up. You would be stuck with the lower rate.
With laddering, you spread out your CDs. For example, if you have $10,000 to invest, you could invest in a five-year ladder with five rungs. You would put $2,000 in each rung – $2,000 in a one-year CD, $2,000 in a two-year CD and so on, up to five years. The longer the term of the CD, the higher the interest rate. In one year, the first CD matures and each CD moves down a rung. You can roll over the first CD into the five-year slot, if you want to keep the ladder going.
- Bankrate.com: Money Market Versus CD Investing
- Bankrate.com: CD Ladder Evens Out Rate Cycles
- Bankrate.com: Money Market Accounts Reward Thrift
- Federal Deposit Insurance Corporation: Certificates of Deposit: Tips for Savers
- Federal Deposit Insurance Corporation: FDIC Insurance Coverage Basics
- National Credit Union Administration
- saving money image by Wojciech Gajda from Fotolia.com
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