How to Choose – Forbes Advisor
Editorial Note: We earn a commission on partner links on Forbes Advisor. Commissions do not affect the opinions or ratings of our editors.
If you’re looking for a place to hold your short-term savings, certificates of deposit (CDs) and savings accounts are good options. Each offers security and interest income. But while these two types of savings accounts share certain characteristics, they serve different purposes in your financial toolkit. The best place to put your money depends on your financial situation and savings goals.
Make sure you understand the limitations and implications of each type of savings vehicle before deciding where to put your money.
What is a savings account?
A savings account is a type of interest-bearing account found at banks and credit unions. They are commonly used to save money for an emergency fund, vacation, down payment on the house, or other financial goals. In other words, a savings account is usually a good place to keep money that you don’t plan to spend right away, but might need access to in the short term.
How does a savings account work?
Savings accounts are quite simple. You put money in your account and your bank or credit union pays you interest on those deposits. If you need your money, you can withdraw it, but you may be limited in certain types of transactions, such as wire transfers or debit card withdrawals, to six per month, depending on your financial institution.
If you need to deposit money into your savings account, you can transfer funds from your checking account or deposit a check or cash at an ATM or bank branch.
What is a Certificate of Deposit (CD)?
A certificate of deposit (CD) is another type of account that allows you to save money at a bank or credit union. While savings accounts and CDs pay you interest on your deposit, a CD is a term deposit. This means that you agree to leave your full balance in the account for an agreed period of time, often in return for a higher interest rate than a savings account might pay. A CD might be a better choice than a savings account if you know you won’t need access to your money right away.
How does a certificate of deposit work?
With a CD, you are guaranteed to earn a certain rate of return on your savings, but you must agree to leave the money on the CD until its maturity date. Withdrawing your funds early could cost you fees and penalties, voiding any interest you may have earned.
In May 2022, the best CD rates for a 1-year forward CD ranged from 1.00% to 1.25%. Minimum deposit requirements vary by institution.
The traditional CD is the most common type, but it is not the only option available. Financial institutions also offer non-traditional CDs, including bump-up, penalty-free, and jumbo CDs. The term, or duration, of CDs typically ranges from six months to five years. CD types and terms vary by institution.
Similarities of CDs and Savings Accounts
CDs and savings accounts have a few important things in common:
- Short-term savings. CDs and savings accounts are good places to put the money you need for your short-term savings goals.
- FDIC or NCUA insurance. Most banks and credit unions that offer savings accounts or CDs are FDIC or NCUA insured, but be sure to double-check before you put your money in.
- Low-risk, low-return investments. Both of these accounts can be good places to keep your emergency fund or short-term cash for specific short-term savings goals, not places to invest for retirement.
- Some cash. Savings accounts will allow you to withdraw your money at any time without penalty (although your bank may limit you to six withdrawals per month). CDs usually charge early withdrawal penalties for withdrawing money before the end of the agreed term, but during the Covid-19 crisis many banks waived these fees.
Differences between CDs and savings accounts
If you’re trying to decide between a CD and a savings account, it’s important to understand the differences:
- To access. When you put money on a CD, you agree to leave your money in the account for a specific “term” or length of time. Unless it’s a no-penalty CD, you’ll incur an early withdrawal penalty if you withdraw your money before the end of the term. Savings accounts don’t require you to make a specific time commitment – you can deposit money into them and withdraw tomorrow if needed.
- Interest rate. Savings accounts typically have a single rate, which changes based on Fed policies and other market conditions. Just because your bank pays a certain percentage on savings accounts today doesn’t mean it’ll still be offering that same rate six months from now (or even next week). With a CD, you get a guaranteed rate for the lifetime of the CD. The APY offered on a CD may vary depending on the validity period of the CD.
Another thing to consider is whether you are in a falling interest rate environment or a rising interest rate environment. Currently, interest rates are at historic lows. If you think interest rates are going to stay low for the foreseeable future, now might be a good time to lock in a CD that pays a higher return than you could get from a savings account.
But if interest rates start to rise and you’re locked into a longer-term CD, you could be missing out on the growth potential of higher-yielding investments. In a rising interest rate environment, locking your money on a CD for too long could be a risky move.
When to choose a savings account?
There are a few financial situations that make a savings account a better place to save your money:
- You need a place to put your emergency fund. If you’re still building your basic emergency cash fund, a savings account is a simple solution. Most experts recommend people set aside three to six months of expenses, and an FDIC-insured (or NCUA) savings account is a great place to keep that money.
- You have short-term savings goals. If you have a financial goal a few years out, you might want to keep that money in a high-yield savings account instead of putting it into riskier investments like stocks. Short-term goals include saving for a down payment on a new car, a home improvement project, or a vacation.
A savings account is often the best and easiest choice for storing your short-term savings. It’s safe, it’s liquid, and depending on the online high-yield savings account you choose, you could get the same or better returns than you could with a CD.
When to choose a CD?
There are several questions you should ask yourself before putting your money into a CD. CDs aren’t the right choice for every situation; some online savings accounts can even offer higher returns than you can get from a CD, without the longer-term commitment.
But there are a few specific scenarios where a CD might be the best choice for your savings:
- You have a specific short-term time frame to maximize your savings. If you’re saving for a specific goal, like a life event or wedding celebration, a new car, buying a new house, or any other major purchase, that has a short-term target date, get a CD with a term that matches your schedule may be the best way to maximize the return on your savings.
- You have a low tolerance for risk and are comfortable with low fixed returns. If you’re a retiree or someone who needs to maximize short-term investment income without the risks of the stock market, CDs might be worth considering. Depending on your situation, CDs could help you earn low-risk, fixed-rate investment income.
CDs can be an attractive part of your overall savings plan. But whether you should invest in a CD depends on a variety of factors. Assess your financial situation and goals before purchasing a certificate of deposit.
You have a choice when it comes to choosing where to put your savings. The best choice for you depends on your investment horizon and overall financial goals. Keep in mind that savings accounts and CDs are generally considered short-term, low-risk, low-return savings vehicles for short-term financial goals.
If you’re 30 and saving for retirement, you shouldn’t put your retirement money in a savings account or CD. Even the most profitable online savings account or the longest-term CD won’t give you the levels of lifetime growth you need for your long-term investments.
It is important to understand the pros and cons of any investment or savings vehicle before committing your money. But, if you’re still building your emergency fund, need liquid savings for a short-term financial goal, or are a retiree who needs low-risk investments with a return decent investment, then either a high-yield savings account or a CD can be an important part of your financial foundation.
Frequently Asked Questions (FAQ)
Which savings account will earn you the most money?
You will likely earn a higher interest rate on an online savings account compared to one at a bank or credit union. The best way to find the highest rate is to shop around to make sure you’re getting the highest rate available for the account that best suits your needs.
How much money should I keep in a savings account?
The answer depends on how much you need to feel comfortable. It’s common for people to keep their emergency savings in a savings account, which can be between three and six months worth of expenses. Remember that the federal government insures most bank and credit union accounts up to $250,000.
How to open a savings account?
To open a savings account, you will need to complete an account application and provide proof of identity and your address. Many institutions allow you to complete this process online.
In some banks you will also need to make an opening deposit. You should also ask if the account requires a minimum balance in order to earn interest.
How to open a CD account?
To open a CD account, you will need to complete an account application, provide proof of identity and address, and make a deposit to fund the CD. Before applying, you will need to decide how long you want to keep your money on deposit. CDs generally offer terms of 3 to 60 months. Banks and credit unions often offer higher annual percentage yields on longer-term CDs.