Savings accounts, money market accounts, and certificates of deposit (CDs) are all deposit accounts insured by the Federal Deposit Insurance Corporation (for banks) or the National Credit Union Administration (for credit unions). All of them are designed to provide a secure place to keep money that you want to save. This makes them different from a checking account, which is designed to hold money for day to day use.
There are important differences between these accounts. They offer different interest rates and minimum deposits, and they have different restrictions on how and how often you may withdraw money. Which one is best for you will depend on your personal needs and financial goals.
What are Savings Accounts?
Savings accounts usually offer very low minimum deposits, making them ideal for handling smaller amounts of money or saving for major purchases that could leave your balance low when you take money out of your account.
Banks usually limit the number of withdrawals you can make from a savings account per month. You will generally be allowed six withdrawals per statement cycle. If you make more withdrawals, you may pay a penalty.
Savings accounts generally do not allow you to write checks against the balance in the account. Some banks may offer ATM access to a savings account, depending on the kind of account it is. Some banks will also let you use your savings account to cover a checking account overdraft if both accounts are at the same bank. You will usually pay a fee for each overdraft.
The interest rates on savings accounts are typically higher than those of checking accounts but lower than the interest paid on money market accounts or CDs. The interest rate on a savings account may fluctuate according to the prevailing market rate. Some high-yield savings accounts, often offered by online banks, may offer higher than average rates.
What are Money Market Accounts?
A money market account is a deposit account offered by a bank or credit union. The money is placed in short-term investments, allowing these accounts to pay higher interest rates than a regular savings account.
Many money market accounts allow easier access to your money than savings accounts would, with options including check-writing, ATM access, and electronic transfer privileges. You may still be limited to a maximum of six withdrawals per statement cycle, and some banks may allow fewer withdrawals.
Money Market Accounts also usually offer higher interest rates than savings accounts. Money market accounts also have relatively high minimum deposits, sometimes much higher than savings accounts. You may pay fees if your balance falls below the minimum. Don’t confuse a money market account with a money market fund. A money market fund is an investment instrument that is not insured and could lose money if the market falls.
Easier access to your money can be convenient but may also make it more difficult to save. If you can get to your money easily you may be tempted to spend it.
What are Certificates of Deposit (CDs)?
A certificate of deposit is much like a savings or Money Market `account but comes as a commitment to keep a fixed amount on deposit for a specific period of time. What this means is that if you withdraw money during that period you may pay substantial penalties. CDs usually pay higher interest rates than savings or money market accounts. The interest rate on a CD is fixed and does not change with market conditions.
CDs are available for different time periods, ranging from a few months up to five years. Longer-term CDs carry higher interest rates. Check the early withdrawal penalties before investing in CDs. CDs with longer terms usually have the highest interest rates, but they also usually have the steepest penalties for early withdrawal.
Some CD investors assure access to funds on a regular basis with a CD ladder, dividing their funds among CDs with different maturity dates. As each CD matures the funds can be used if they are needed or placed in a new CD if they are not. CD ladders can be structured in different ways to meet different financial objectives.
If you are preparing to invest substantial sums in CDs and your goals are long-term, like funding retirement, you may wish to speak to a professional financial adviser about setting up an investment portfolio with potentially higher yields.
Which Option is Best For Me?
Each of these account types has advantages and disadvantages, and each is appropriate for different uses. Understanding these advantages and disadvantages can help you choose the account that will best meet your financial objectives.
Savings Accounts
Advantages:
- Savings accounts typically have low minimum balances and minimal fees.
- Some savings accounts may provide access to ATMs and electronic transfers.
- Some banks may allow you to use your savings account to protect you from checking account overdrafts. You may pay a fee for this service.
Disadvantages:
- Savings accounts usually have the lowest interest rates of these three account types.
- Most savings accounts allow only six-monthly withdrawals, or in some cases even fewer.
Low fees and low minimum balances make savings accounts ideal for young people or others who are just beginning to save money. They are a good choice for short-term savings goals, such as saving for a major purchase that may leave you with a low account balance. If you have consistently high balances in your checking account, a savings account can help you earn interest on that money.
Remember to check online banks if you’re looking for the highest interest yield on a savings account. Some online banks offer interest rates close to those of money market accounts.
Money Market Accounts
Advantages:
- Money market accounts usually pay significantly higher interest rates than savings or checking accounts;
- Many money market accounts allow check writing, ATM access, or electronic transfers. You may need to ask your bank for access to these services.
Disadvantages:
- Money market accounts usually have high minimum balances, and you may pay substantial fees if your balance drops below the minimum. The accounts with the highest interest rates may also require the highest minimum balances.
- Money market accounts will also limit your withdrawals, usually to six or fewer per statement cycle.
Money market accounts are ideal if you have larger savings to work with and you’d like to earn higher interest while retaining some access to your funds in case of emergencies. A money market account can be a good choice for holding an emergency fund or money that’s waiting for an investment opportunity.
Remember that easier access to your money is not always an advantage when you’re trying to save. If you can reach money easily you may be tempted to spend it!
Certificates of Deposit (CDs)
Advantages:
- CDs usually pay higher interest than savings or money market accounts.
- The interest rate on a CD is fixed for the term of the account, so you know exactly what you will earn.
- If you hold your CD to maturity you will usually pay no fees.
- CDs are available in many different terms, giving you a choice of how long you wish to lock a sum of money away.
Disadvantages:
- If you withdraw your money before the term of the CD is complete you will pay substantial penalties.
- You will not have access to check writing, ATMs, or electronic transfers.
CDs are ideal for long-term savings for long-term goals like retirement, a down payment on a mortgage, or a child’s education. If you’re sure you won’t need the money and you want to earn the highest interest rate you can while retaining the security of deposit insurance a CD is likely to be your top choice.
Remember that a CD ladder can help you get the benefits of a CD with access to some of your funds at regular intervals.
Choose Your Account and Save!
Saving money is an essential part of any financial plan, and all three of these account types are useful and secure ways to save. All three usually insured up to $250,000, minimizing your risk. All three pay more interest than you will get from your checking account. Your choice will depend on the amount you have to save and on your personal financial objectives.
Remember that you’re not limited to one account. You can start with a simple savings account and then move to a money market account or CDs as your savings grow and you start focusing on longer-term goals. Whichever account you choose, a decision to save money is a key step toward a better financial future!
