Savings accounts and CDs (certificates of deposit): Which should I choose?
Either of these ways of saving can be an important piece of your financial strategy, but each one has different benefits. Here’s how you can choose what best fits your needs.
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Got money left over after paying your bills and thinking about socking some of it away? Savings accounts and certificates of deposit (CDs) can both be effective ways of setting aside money for short-term goals. One—or maybe both—of these could be right for your situation, depending on your savings priorities and the time you need to reach those goals. This comparison can help you decide.
What's the difference between a savings account and a CD?
With a savings account, you’ll have easy access to your money and earn a little interest on the balance. A CD typically pays more interest, but access to your money is limited.
The most basic account for saving available through a bank or credit union, this kind of account allows you to easily and securely deposit money while earning a small amount of interest on your balance. Deposits up to $250,000 are insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration. You can withdraw your money whenever you want—in some cases with an ATM card— though there may be limits on the number of transactions you’re allowed to make. Most savings accounts have maintenance fees, though the fees may be waived in some cases.
A certificate of deposit offers a fixed interest rate that’s usually higher than what a regular savings account offers. The tradeoff is you agree to keep your money in the CD for a set amount of time, typically three months to five years. If you withdraw your funds before the maturity date, you’ll probably have to pay a penalty. Some banks offer products with penalty-free options. It is important to look closely at the available products and features to find the CD that most closely meets your needs. As with savings accounts, CDs are federally insured up to $250,000.
Did you know?
The penalty for withdrawing money before the CD’s maturity date can be a flat fee or a percentage of the interest earned. In some cases, it could even be all the interest earned, canceling out your efforts to use a CD for savings.
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How are interest rates determined?
With a traditional savings account, the interest rate is variable—in other words, it can go up or down over time based on market conditions. You may be able to get a slightly higher rate from your bank based on factors like a large savings balance, linked checking and savings accounts, additional accounts or participation in a rewards program.
CDs generally offer a fixed interest rate, so it won’t change during the account’s term. The rate depends on market conditions at the time you open the CD, the CD’s duration and the amount of your deposit.
Overall, the biggest advantage of CDs is the higher interest rate. But it’s important to be aware of what’s happening with interest rates in the economy before investing in CDs. When rates are rising, it’s possible to miss out on a higher return because your money is locked in a CD with a lower rate. On the other hand, when rates are falling you could benefit if your fixed rate is higher.
Did you know?
The Federal Reserve brings interest rates up or down as a way of helping keep the economy stable. Roughly every six weeks, its Federal Open Market Committee (FOMC) meets to decide whether to raise, lower or leave alone the federal funds rate—that’s the rate banks charge each other for overnight loans. The banks, in turn, generally raise or lower their own savings and lending rates based on the Fed’s actions.
When to use savings accounts
If you’re just starting to save for short-term goals or to establish an emergency fund, a savings account might be a good bet. It also makes sense if you’re planning to make a big purchase—such as a refrigerator, vacation or down payment on a car—within a year or so.
In addition, savings accounts are great for teaching children the basics of money management while helping them set savings goals, take pride in watching their balance grow and understand the value of compound interest.
Quick tip
Use a savings account, rather than a CD, for your emergency fund to ensure you can get the money when you need it.
When to use CDs
Two big selling points for CDs are their safety and the variety of term options they offer. While they don’t have the growth potential of stocks and bonds, CDs can be a smart way to save for longer-term goals without the risk of market downturns.
But because access to your money is limited, CDs work better for longer-term goals—a wedding, next year’s tuition, a down payment on a home. They can also be a useful addition to a diversified retirement portfolio.
Quick tip
Creating a CD ladder means buying multiple CDs that mature at different times and at interest rates that increase as their maturation dates get longer. Doing this can help protect your money from changing interest rates and allow you to take advantage of longer-term CDs’ higher rates, while giving you regular “payments” as your shorter-term CDs mature. If you don’t need the money at that time, you can reinvest in another short-term CD.
| | Savings accounts | CDs |
|---|---|---|
| Interest rate | ||
| Interest rate | Low variable rate. | Fixed rate that’s higher than a savings account. |
| Access to money | ||
| Access to money | Whenever you want, up to set number of transactions. | Product specific, generally when term ends. Before that, penalties could apply. |
| Minimum initial deposit | ||
| Minimum initial deposit | Varies. At | Varies. At |
| Fees | ||
| Fees | Typically, a monthly fee. | Typically, no monthly fee. |
What are high-yield savings accounts and money market accounts?
Beyond regular savings accounts and CDs, there are some other effective ways to save:
These accounts typically offer interest rates many times higher than those offered by a traditional savings account. They’re often available at online-only banks, which can offer higher rates because their overhead costs are lower than those of brick-and-mortar banks. In most ways, high-yield accounts operate like regular savings accounts, though you might need to make a larger initial deposit and maintain a minimum balance.
These accounts provide many of the benefits and features of both savings and checking accounts. They generally pay higher interest rates than regular savings accounts, and they come with debit cards and limited check-writing privileges, allowing easier access to your money than CDs. However, they offer less flexibility than regular checking accounts, usually by limiting the number of transactions. In addition, they may have minimum balance requirements.
You don’t have to pick just one of these savings options. In fact, it often makes sense to have a mixture of CDs and different types of savings accounts as part of your overall savings strategy.
