CDs vs. Other Savings Accounts: Open for Comparison
CDs vs. Other Savings Accounts - What to Choose?
We all know that we should save money. The question is how do we save it and where to do it. There is never a bad time to start saving money, but choosing an avenue to do it through should be considered carefully. While all wealth management tools provide benefits, they all come with their own risks, too.
And as they are not all created equal, they are not all made for each person and for each walk of life. Each tool has the propensity to help you successfully manage your money to some degree, but much of that success will depend on your needs, your goals, and your current financial standing.
Here we discuss some of the different savings avenues and compare CDs vs. other savings accounts.
What Exactly Are CDs?
CDs are just one of the many financial management tools available to you. They allow you to park your cash at a locked-in rate for a set period of time- either months or years. Here are the pros and cons of choosing CDs vs. other savings accounts:
Pros
When considering CDs vs. other savings accounts, you will find quite a few benefits.
Cons
Of course, there are downsides to choosing CDs vs. other savings accounts.
Higher Interest
You tend to earn a higher interest rate with CDs vs. other savings accounts. Additionally, you lock in the interest rate at which you earn when you deposit the money into the CD. This means that if you agree to a 2.5 percent interest rate upon opening the CD, you earn that same interest rate for the full term of the CD, even if market rates drop.
No-Risk
Typically, there is no risk to putting your money into a CD as long as the CD is insured. It is easy to confirm this prior to getting the CD.
History of Success
CDs have been around for a long time. When I was little, my grandparents always told me to put my money into CDs. Most of the kids I knew had parents and grandparents that would put money for the kids into CDs. The kids could then cash out when they were grown. They have a good track record, which makes them much easier to trust and feel comfortable with.
Special Rates
Sometimes, banks and credit unions offer great promotional rates to gain business. If you decide to put your money into CDs vs. other savings accounts, check around for promotions before choosing one.
Minimum Deposits
For the most part, savings accounts do not require a minimum deposit. If they do, it is a relatively small amount. CDs vs. other savings accounts, however, do tend to require minimum deposits. The amounts will vary, though. While you might get a surprise for a lower requirement, you can expect most of the CDs you find to require at least $500. There are some that require thousands. With some research, you should be able to find one to fit your budget.
Taxes
As with any investment, you are charged taxes on the interest you earn. This should not be a deal-breaker, though. Better to pay taxes on money that you did not have before than to not earn it at all. This is just something to keep in mind.
Penalties
One of the reasons you get a higher interest rate with CDs vs. other savings accounts is because you are agreeing to leave your money in for the entire CD term, whether that is a few months or a decade. If you choose to withdraw the money before that term is up, you not only have to pay penalties but you also risk losing the interest you have earned. In short, it costs you to withdraw that money prior to the end of the term, which is bad if you really need that cash for something.
Think about it like this: When you put your money into a CD, you are basically handing over ownership of your money for the term of the CD. It is literally theirs until the CD matures. If you wait until the maturity date, the money becomes yours once again and you earn some extra for loaning your money to that institution.
If, on the other hand, you need that money prior to the maturity date, you are not withdrawing your own money. It is like borrowing money back from the institution and they are charging you for giving it to you.
Locked-In Interest
Since you are locked in with an interest rate, you might end up on the losing side. Sure, you do not have to worry about that interest rate dropping, but what if the interest rate increases? You are still stuck with your locked-in rate.
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When Shouldn’t I Choose CDs vs. Other Savings Accounts?
Remember, once your money goes into the CD, you cannot take it out without penalties. While there are good times to choose CDs vs. other savings accounts, there are plenty of times you should not. Some of the main ones include:
Emergency Fund Money
If the money you are looking to put away is your emergency fund money. The point of an emergency fund is to have the money available when an emergency occurs. Putting your emergency fund into a CD is kind of working against that.
You’ll Need Money Prior to the End of the Term
If there is a decent chance you will need that money earlier. Even if the money is not your emergency fund, you might need it. Though you cannot know the future, one can usually tell if they might need that money soon. For instance, if you are already struggling to pay your monthly bills, tying money up into CDs is probably not the best move at that time. Your finances do not have to be perfect, but you do not want to have to touch the CD until it matures.
How to Make CDs Work For Your
If you really want to invest in CDs but are afraid that you may not be able to leave your money in for the long term, there is a strategy you can try. It is referred to as a CD ladder. There are several types of CDs that have a wide range of terms. Many people have learned to use this to their advantage.
Some of the types of CDs include:
Traditional CDs
These tend to have really stiff penalties for early withdrawal.
Bump Up CDs
With these, if the interest rate happens to rise, you can request that your interest be increased for the remainder of the term. However, they often start out at a lower interest rate than others.
Liquid CDs
Some institutions offer this option that allows you to withdraw money without penalties.
High Yield CDs
These offer two or three times as much as the average interest rate.
Jumbo CDs
These require much higher deposits than other CDs, but you usually also get much higher interest.
CD Ladder
There are other types, as well, but these are the most common. If you want to try the CD ladder method, it is actually pretty simple. Basically, instead of putting all of your available money into one CD, you spread your money out among several CDs. Be sure that you deposit money into very short term CDs. These do not offer high-interest rates since you are not leaving the money in for long, but there is the benefit of getting the money quickly.
When the short term CDs mature, you take that money and purchase new CDs with different terms. You continue this cycle for as long as you want. The benefit is that you have a steady flow of CDs maturing but still have some money invested in those with longer terms that provide higher interest rates.
This CD ladder prevents you from having to withdraw all of your money early and pay penalties. If, for some reason you need to use the money from a CD that just matured, you are not losing anything or being punished for it.
Savings Accounts
Pretty much everyone knows what a savings account is, so there is really not much need to go into them. Basically, though, it is another place that you can put your money and earn interest. As banks are FDIC insured up to $250,000, you can feel safe putting your money there. How do savings accounts stack up against CDs, though, and when should you choose a savings account?
Pros
Savings accounts have some interesting benefits to consider.
Cons
Remember, there is good and bad with everything, and that includes savings accounts.
Easy Access
When comparing CDs vs. other savings accounts, the biggest benefit of a savings account is that you can more easily access your money. Unlike a CD, you can withdraw your savings without penalties.
Interest
You are not locked into an interest rate when it comes to savings accounts. This means that if the interest rate increases, it increases for you, too. At times, you may earn more from a high yield savings account than you would a CD.
Limits
While you can withdraw your money from a savings account, you can only make a certain number of withdrawals per month, which is typically six. This is not your bank’s rule- this is actually federal law. The good part is that there is no limit to the amount you can withdraw- as long as you have that amount in the bank. If you need to withdraw your full balance all six times in a month, you can do that. You just cannot make more than six withdrawals, so make them count when you need to access your money.
Interest
While not having a locked-in interest rate can be a positive thing, it can also be a negative one. It means that at times, you may be earning less than you would with CDs. It also means that you will not know how much you are earning until the bank tells you, and it can fluctuate every month. In other words, you cannot really plan it. With CDs, you know how much you will have earned by the end of the term. That is not the case with savings accounts.
When Should I Choose a Savings Account?
A savings account is best when there is a chance you will need to access your money quickly. This makes savings accounts the better option for your emergency fund. If you break down on the side of the road and need to replace a tire, you can easily take out the money and lose nothing but the interest you would gain if the money stayed in your account.
Below you can take a look at some of our favorite savings accounts. Check them out and decide which one works best for you:
Different Types of Savings Accounts
There are several different types of savings accounts, too, in addition to regular banking. You should choose your savings accounts depending on your financial goals. Some well-known savings accounts are as follows:
529s
529s are college savings accounts. Parents start them for their children and invest in them throughout the child’s young life. The money is then available to that child when he or she goes to college.
529s are not tax-deductible, but they are very beneficial. The money can grow tax-free and any distributions are not taxed if they are going towards qualifying educational expenses for students who are enrolled at least half time. The money does not have to be used for educational expenses, but taxes are involved when it is used for anything else.
IRAs
IRAs, or individual retirement accounts, are just one way to save for retirement. Any investment earnings are tax-free. You can deduct up to $5,500 per year for a 10 percent penalty- if you are under 59 ½ years old. Also, withdrawals are subject to be taxed.
Roth IRAs
These are mostly the same as regular IRAs. The big difference is that contributions to a Roth IRA are taxable.
401k
A 401k is another retirement savings vehicle yet these typically come through an employer. They allow you to have contributions taken directly from your pre-tax pay and the employer often matches some of your contributions. Your earnings are tax-free until you withdraw from it. If you withdraw prior to age 59 ½, there is a 10 percent penalty.
Mutual Funds
Mutual funds are another avenue people go down for saving money and earning interest. Mutual funds are a collection of bonds, securities, and stocks that multiple people invest in. This makes them less risky than many other investments as the risk is spread around. It is also highly likely to earn more from mutual funds than you do from other savings accounts.
Finally, let’s sum up and answer three very important questions: What is money management, how can I do it well, and how can it benefit me?
What Is Money Management?
In short, money management is watching over your income and outflow of money. It means to control your money by saving, investing, budgeting, and spending wisely. Managing your money well means watching where your money goes, ensuring it is going to the best places, and making any needed changes as you discover issues.
Some benefits of good money management are:
Having the money necessary to pay your bills and pay for necessities.
Having money to put away instead of having to live paycheck to paycheck.
Being able to meet your financial goals.
Getting to enjoy activities without worrying about finances.
Saving for retirement.
Having an emergency fund put away so when- not if- an emergency happens, you are not thrown off track.
Getting to live without debt.
Having good credit so you can purchase a house or a car if you choose with good interest rates and good terms.
The benefits are endless and can be very personal. The bottom line, though, is that managing your money well means that you have more freedom and less financial stress.
Conclusion
Choosing between CDs vs. other savings accounts should revolve directly around your personal preferences, your financial goals, and your financial situation. As you can see, each of these financial management tools has its own benefits and risks. The key is to be educated and to consider each carefully. As with any financial decision, you should consider consulting a financial advisor to help you make the best choice for you and your family.