Whether you’re putting aside funds for a rainy day, or a sunny summer vacation, saving money is an absolute must. When it comes to how you save, two of the most popular options are savings accounts and certificates of deposit. The best way to determine which choice is ideal for your situation is to understand the benefits of both.
What is a savings account?
Margarette Burnette, an expert on savings accounts with NerdWallet, writes that a savings account is a great option if you want more flexibility. When you open a savings account with your financial institution, you can access the money as you wish. This makes a savings account particularly helpful for emergency expenses like broken appliances or home repairs.
Some accounts may limit the number of transactions you can make in a month, typically maxing out at six withdrawals. Any withdrawals or transfers thereafter would be subject to a small transactional fee. However, the Federal Reserve System announced an interim change to Regulation D in April 2020 that permits financial institutions to suspend the six-transfer limit at their discretion.
But even at a limit of six withdrawals per month, a savings account is a more liquid option than a CD. The liquidity of a traditional savings account comes at the expense of a high interest rate. Most accounts yield well below one-tenth of a percentage point of interest, though you can earn more interest by opting for a high-yield savings account.
What is a certificate of deposit?
According to Certified financial planner Justin Pritchard of The Balance, certificates of deposit are beneficial if you want to accrue more interest. A CD is a longer-term commitment — when you purchase a certificate of deposit, your money is more or less locked into that account until it reaches maturity. You can make early withdrawals, but you’ll pay penalties that can wipe out the advantage of the higher interest rate — unless you can secure a no-penalty CD, which yields a lower interest rate.
According to Pritchard, CDs pay higher interest rates than savings accounts, and they tend to be even higher the longer your term. Maturity terms for CDs range from as little as three months to the typical maximum of five years. With most CDs, you’ll earn the same rate of interest for the entire term. Bankrate contributor Libby Wells notes one exception is a bump-up CD, which lets you opt for a higher rate once over the term if the rate rises.
What is the best strategy for you?
If you’re torn on whether a savings account or CDs are right for you, consider the fact that you don’t necessarily have to choose. You can easily have both and build a smarter, more diverse savings strategy.
Opening a new savings account is simple, and according to Burnette, most don’t require a minimum deposit to start. If you have a larger sum of money to work with, you could opt into a money market account, which functions like a savings account with a higher interest yield. With the advent of mobile banking, it’s entirely possible to manage multiple checking accounts, savings accounts, and MMAs.
Supplementing savings accounts with CDs is a great way to get a mix of access to funds and higher interest rates. You can also open multiple CDs to maximize your money’s earning potential. NerdWallet contributor Spencer Tierney recommends among other strategies the CD ladder approach, where you divide a sum of money across five CDs with different maturity rates. This allows you to roll interest over into new CDs and have a more open line of access to your funds if you need them.
Diversity is never a bad choice when it comes to saving for the future. If you’re looking for ways to get the most out of your money, talk with your financial advisor and craft a plan that will set you up for success.