Savings play a crucial role in achieving financial stability and peace of mind. The importance of savings can be broadly recognized in three main aspects: emergency funds for unexpected events, investment opportunities to grow and secure our financial future, and fulfilling personal goals, whether it’s purchasing a new home or traveling the world.
One of the ways to grow your savings is to deposit money into a CD (certificate of deposit) or savings account. By doing so, you can earn interest on your balance and compound that interest into even more significant returns! Compound interest is where the interest earned on deposited money is reinvested, resulting in exponential savings growth over time.
Exploring different savings products such as CDs can increase your overall financial well-being.
CD (Certificate of Deposit) Overview
How a CD Works
A CD, or certificate of deposit, is a type of savings account that typically offers a higher interest rate than a traditional savings account. When you open a CD, you agree to leave your money in the account for a fixed period, typically ranging from a few months to several years. In exchange for leaving your money in the account for this period, the bank offers a higher interest rate than it would for a traditional savings account.
Once the term of the CD is up, you can withdraw your money and any interest that has accrued. If you withdraw your money before the term ends, you may have to pay a penalty fee.
Advantages and Disadvantages of Having a CD
One advantage of having a CD is that it typically offers a higher interest rate than a traditional savings account, which can help your money grow faster. The interest rate is also fixed, meaning you are guaranteed a certain amount of money upon the CD maturing. This can better help you plan your finances. Additionally, CDs are considered low-risk investments because the FDIC insures them for up to $250,000 per CD.
However, one disadvantage of having a CD is that you must leave your money in the account for a fixed period of time, which means you cannot access your funds without paying a penalty fee. Brokered CDs are a type of bank CD offered by a brokerage. Brokered CDs have almost all the features of a bank CD, but frequently pay more than normal CDs.
You may want to explore a CD ladder to explore a strategy with more short-term access to cash. Additionally, the interest rate for a CD is fixed, so the tradeoff is that if interest rates rise during the term of your CD, you may miss out on higher returns.
Comparison of CD Interest Rates with Other Investments
CDs offer a low-risk investment option with predictable returns. According to the Federal Deposit Insurance Corporation (FDIC), the average annual percentage yields (APYs) on CDs with terms ranging from one month to five years was between 0.26% to 1.59% as of 2024.
While other investments such as stocks and real estate may offer higher returns, they also come with more risk and require more research and management.
One popular cash alternative is the Treasury bill. T-Bills are issued by the U.S. government directly and are usually an investment that many banks themselves buy to earn more interest income. T-Bills can be bought directly on most brokerage platforms and offer a safe, interest-bearing cash alternative to CDs.
Factors to Consider Before Investing in a CD
Firstly, you must identify the purpose of the investment and determine how much money you can afford to invest. Secondly, you must evaluate the interest rate and the term of the CD. The interest rate is the return on your investment, and the longer the term of the CD, the higher the interest rate. However, a longer-term CD will tie up your money for a longer period.
Another factor to consider is the penalties for early withdrawal. Make sure you are comfortable with your cash requirements and do not need the money before the CD has matured.
Savings Accounts
How A Savings Account Works
A savings account is a type of bank account that allows individuals to save money and earn interest on their deposits. When you open a savings account, you deposit money into it, which the bank uses to invest in its operations. In exchange for using your money to generate its profits, the bank pays you a certain interest rate, usually calculated on an annual basis.
The interest rate may vary depending on the bank and its policies. Unlike a checking account, where frequent transactions are made, a savings account is designed for accumulating money over time. Most savings accounts have withdrawal constraints and may charge a penalty for early withdrawals.
Advantages and Disadvantages of Savings Accounts
Savings accounts often offer higher interest rates than checking accounts, which means that the savings can grow over time and compound. However, the interest rates offered by savings accounts are usually much lower compared to the interest rates and yield you get from CDs and other financial products. This is also common in many high-yield savings accounts, which do not pay fixed rates like CDs.
Some banks charge fees for maintaining savings accounts or withdrawals beyond a certain limit, which can eat into interest gains. In addition, savings accounts do not offer instant access to funds and may not be suitable for emergency situations.
While savings accounts are a safe and risk-free way to keep your cash safe, they are not the most ideal way to grow your existing wealth.
Comparison of Savings Account Interest Rates With Other Investments
In 2024, the national average interest rate for savings accounts was between 0.50% and 1.50% APY (annual percentage yield). While these rates provide a secure and conservative option for individuals looking to preserve their funds, they do not offer the same level of return as Certificates of Deposits (CDs).
As a result, many individuals may opt for CDs when seeking higher returns on their investments, although these investments come with a fixed term and limited liquidity compared to savings accounts. As an example, most Merrill Edge CDs pay over 5%, a considerable boost to cash income compared to high-yield saving rates.
Factors to Consider Before Opening a Savings Account
Before investing in a savings account, it is important to consider your preference for short-term access cash as a trade-off with higher interest rates. Savings accounts offer higher rates than checking accounts, but lower rates compared to CDs and other fixed-income products. However, CDs generally require a larger minimum investment and will have more restrictions on access to funds.
Comparing CDs vs. Savings Accounts
Here is a brief overview of the key features of CDs and savings accounts:
| Aspect | CD (Certificate of Deposit) | Savings Account |
| Purpose | Saving money for a fixed period of time | Saving money for immediate or short-term needs |
| Term | No fixed term can be short-term or long-term | No fixed-term can be short-term or long-term |
| Interest Rates | Generally higher interest rates than savings accounts | Typically lower interest rates than CDs |
| Liquidity | Less liquid; funds are locked in for the term | More liquid; funds can be easily accessed or withdrawn |
| Penalty for Withdrawal | Early withdrawal penalties may apply | No penalties for withdrawal unless account-specific limits |
| Minimum Balance | Often requires a higher minimum deposit | Generally requires a lower minimum deposit |
| Account Accessibility | Generally considered low-risk | Frequent access to funds |
| Risk | Generally considered extremely low-risk | Minimal risk |
| Insurance Coverage | FDIC (up to $250,000 per depositor per institution) | FDIC (up to $250,000 per depositor per institution) |
| Investment Potential | Limited investment potential | No investment potential |
Conclusion
A CD and a savings account are both financial tools designed for saving money, but they differ in terms of returns, accessibility, and timeframe. CDs generally offer higher interest rates than savings accounts. However, CDs require a fixed-term commitment, typically ranging from a few months to several years, and may impose penalties for early withdrawal. On the other hand, savings accounts provide more flexibility, allowing for easy access and deposits or withdrawals without penalties, but usually offer lower interest rates.
If someone is saving up for a down payment on a house and knows they won’t need the money for at least two years, they may want to consider putting it in a CD instead of a savings account. The CD will likely offer a higher interest rate and the money will be locked in for the agreed-upon term, which can help the person resist the temptation to dip into their savings before they’re ready to make the big purchase.
It’s important to prioritize putting away cash for unforeseen expenses or plans, regardless of the method. Earning additional income through a CD or savings account will provide peace of mind and a safety net in case of emergencies or valuable investment opportunities.
