If you’re looking to grow your money, you may be thinking about opening a savings account. Or perhaps you’re thinking a certificate of deposit may be the better option for you. Maybe you’re uncertain of the difference and need a little help figuring it all out. We have you covered. We’ll break down the differences between a certificate of deposit vs. a savings account so you understand which one makes the most sense for your finances.
Certificate of Deposit vs. Savings Account
A savings account is a good place to sock away some cash for large expenses. You may want to buy a home, for instance, and need to save for the down payment. Or maybe you have some vacation time to use and you want to take the family on a dream vacation. A savings account is a good place to put money aside for these types of short-term goals.
The same goes for a certificate of deposit (CD). It can be an excellent place to store your money and even earn a little extra through interest accrued on your initial deposit. But there are a few key things to know before you run to the bank to open one.
For starters, while both credit unions and banks typically offer savings accounts, you’ll only find CDs at banks. Credit unions offer share certificates, however, which operate similarly to CDs. Here are some other factors to consider before deciding if a certificate of deposit or a traditional savings account is the best option for you.
Interest Rates
Do you want to maximize the money you’re able to earn on your savings? Compare the interest rates of the accounts you consider. According to Bankrate, interest rates offered on top CDs and savings accounts outpace inflation. So you’ll be sitting pretty either way. However, you should still do your research and compare the annual percentage yield (APY) for each.
Once you have compared APYs, the next step is to compare how frequently the APY compounds. Compound interest is the interest paid on both the principal amount deposited and the interest the funds accrue during the term. The APY can compound daily, weekly, monthly, or annually. The more frequently the APY compounds, the more quickly your money will grow.
In fact, you can see how compound interest works for yourself with this compound interest calculator provided by the US Securities and Exchange Commission (SEC). It allows you to compare both the APY and the frequency at which the APY compounds to determine which type of account is the wiser investment.
Are you interested in learning more about compound interest? You can test your knowledge and learn about other related concepts with this SEC educational investing quiz.
Limitations
Another thing to keep in mind is flexibility. A savings account is fluid. It allows you to deposit and withdraw funds from the account as needed (though, some savings accounts will assess a fee if your withdrawals exceed a certain number in a given month). You’re also able to open a savings account with a fairly small deposit and then add to it in the future.
A CD, on the other hand, is more restrictive. When you open a CD or share certificate, you’re usually limited to just your initial deposit—meaning you can’t add funds to the account during the set term. In addition, once that opening deposit is made, you’re typically unable to withdraw any funds before your CD has matured; that is, until its full term has elapsed. If you have an emergency expense and need to withdraw funds before your CD fully matures, you’ll likely be hit with a penalty fee.
Terms typically last from three months to five years, based on your preference and needs and the financial institution, so it’s important to keep these restrictions in mind since you’ll have limited or no access to those funds for that time.
Security
When you deposit your hard-earned money in any type of account, you want to know your funds will be there when you need them. We have good news. Whether you choose a certificate of deposit, share certificate, or a savings account, you can feel confident that your money is safe and secure. These types of accounts are insured up to $250,000 through the FDIC if you work with a bank and through the NCUA if you work with a credit union.
Choosing a Certificate of Deposit vs. a Savings Account
How do you decide if a CD or a savings account is the better option for you? We recommend keeping two important factors in mind when choosing: interest rates and potential penalties for early withdrawal.
Certificates of deposit tend to have higher interest rates than traditional savings accounts and might therefore seem like the obvious best choice, but ask yourself if there’s any chance you might need to withdraw the funds before the maturity date. For instance, are these funds your only emergency funds, or do you have another account set aside for that? If there is a chance you need to access the funds early, ask your financial institution how much of a penalty they charge.
If it’s a small amount, you may decide the payoff of a CD might still outweigh the risk. On the other hand, if the early withdrawal fee significantly cuts into the interest you’d accrue, you may be better off opening a traditional savings account instead. You may even be able to find a savings account with as much of a reward but without the risk of an early withdrawal penalty.
Whichever type of account option you choose, we recommend checking out the options at your local community credit union. They often offer the most competitive rates. Based in the Mid-Hudson Valley area? Open a share account or savings account at Mid-Hudson Valley Federal Credit Union. You’ll be able to qualify for high dividends on savings simply by joining.
The important thing is that you’re already doing your research. By educating yourself, comparing interest rates, and thinking about your financial goals, you’ll be able to decide between a share certificate vs. a certificate of deposit vs. a savings account with no trouble at all.
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