This article will help you make an informed decision about which may be best for your situation, a Savings Account or CD (Aka “Certificate of Deposit”).
Some of the most common places that people keep their money are:
A Checking Account
A Savings Account
A Certificate of Deposit (CD)
What are the differences between these types of accounts and which is the best for you?
Let’s start with some sobering news. A recent survey revealed that 69% of Americans have savings account with balances of less than $1,000. Even more alarming is the fact that 34% of Americans don’t even have a savings account.
Why is it important to save money?
Saving money is important for many reasons. Most Financial advisors recommend that people have at least three to six months worth of living expenses set aside as an emergency fund. This is to ensure that they will have resources available to cover any unexpected expenses like the loss of a job or medical emergencies. It is also wise to set aside money for future purchases like a car, home or a child’s education. However, trying to figure out where, when and how to save money is not that easy to do. In fact, it can be quite complicated and that might be at least part of the reason so few people do it!
What is a Checking Account?
You’ll sometimes hear a checking account referred to as a “transactional account” or “demand account”. Your money, when deposited in a checking account offers a high level of liquidity. The interest rate paid on your checking account balance (if any) is lower than it would be in a Savings Account or Certificate of Deposit. With a checking account, you can access your funds anytime using a debit or ATM card or by writing a check. A checking account is ideal for everyday spending because most banks don’t place a lot of restrictions to it. With most checking accounts, you can make unlimited deposits and as many withdrawals you need each a month.
Checking accounts may come in different packages. Make sure to choose the one that suits you best so you can also save on fees. If you opt for a basic checking account, expect that you will be charged with a certain fee if your balance goes too low. If you choose an Express checking account, you will not be required to pay for a monthly fee. In an Express checking account, you will have access to ATM, personalized checks and unlimited check writing. If you opt for the services of a teller, you will have to pay a per-visit service fee.
Checking accounts can be set up at your bank branch in person. You can also set up a checking account through most bank’s websites. With the latest advancements in electronic banking, people can now use their checking account for paying their bills online. They can also make deposits or money transfers using smartphone apps.
A checking account is most suitable for people who frequently need to access their money for daily expenditures. But, if you really want your money to grow over time, a savings account or certificate of deposit will almost certainly be a better option. Below is some helpful information to help you decide which one is better – a Savings Account or a Certificate of Deposit? Continue reading to learn more!
What is a Savings Account?
The money you place in a savings account should be money you do not need access to on a daily basis. Money deposited in a savings account will earn interest over time – in other words, your money will grow in a savings account. This account is also referred to as “statement savings” or “passport savings”.
Making deposits into a savings account can just be done online or through a mobile app. Generally, there aren’t any monthly limits as to how many times you are allowed to deposit money into your savings account.
But, there can be a limit to how many times you are allowed to withdraw money from your savings account each month. For each withdrawal transaction, depending on the type of savings account you are using, fees may be incurred. If you withdraw more often than the allowed limit, you may be asked to downgrade your account to a checking account. Making withdrawals can be made easier through the use of a debit card that is tied to your savings account. You can use this card at any affiliated automatic teller machine (ATM).
Savings Account Advantages
Savings accounts offer protection for your money through a government backed agency called FDIC (Federal Deposit Insurance Corporation). Account holders must double check with their bank whether it is FDIC insured. This way, even if the bank fails, you are assured that your money is protected. However, not all money that you deposited in the bank is covered by the FDIC. Generally, banks offer protection for accounts that have at least $250,000.
What is Bank Failure?
Bank failure means the bank is closed for business as mandated by the state banking regulatory agency. This occurs when the bank is no longer capable of meeting its obligations to their bank depositors.
How Do I Know if the Bank is FDIC Insured?
If you want to know whether your bank is FDIC insured, visit FDIC’s Bank Find site. Fill in the name of the bank, city, state and zip code and then click the “Search” button to find the exact match.
- Another advantage of a savings account is that the money is liquid. If you need to withdraw money you can do it immediately without any waiting period. So, you have the comfort of knowing that you can easily access your funds at any time and for any reason.
- Once money is placed in the savings account it will start to earn interest. The interest rate may be compounded everyday, every week, every month or on a yearly basis. Interest rates will vary from bank to bank. The same is also true with the monthly service fees and the methods for calculating the interest rate. The minimum opening deposit may also vary in each bank.
- It is important that a person must clearly understand first all the terms and benefits involved in a savings account before actually signing up for one.
Savings Account Disadvantages
- Savings accounts offer very low interest rates today. The interest rate for savings accounts is usually lower than certificate of deposit. As of the writing of this article, a typical savings account will one percent interest or less. This serves as a tradeoff for the security, easy access and safety that comes with this type of account. This is why a savings account is not the best option if you want your money to grow.
- A typical savings account limits the number of withdrawals that you are allowed to make on a monthly basis. Transfers to and from savings accounts can also be limited.
- A minimum balance can be required in order to receive a certain interest rate. However, you are usually offered an option to select a savings account that has no minimum maintaining balance. But, the yields on those accounts can be too small and you may be required to pay a monthly account fee. Account fees can range from $5 to $10 or more. Higher yield savings account will most likely require you to have a maintaining balance of at least $100-$500.
- But, even though your savings account offers high interest rate, it is still not high enough to be considered a good way to make your money grow. This is because there are other better options available that allows you to earn a higher interest than what your savings account offers. You might want to consider putting your money into a money market account or CD to ensure higher yields. However, the interest rate you earned from your savings account may be good enough for you to grow your money that is otherwise only considered as your “rainy day” fund.
A savings account may serve as a good vehicle for your emergency funds. This is ideal if you do not need the money at present but you would like that money to be available for any unplanned expenses. Although different financial institutions offer different interest rates, a savings account will usually have the following features.
- Savings Accounts do not have maturity dates.
- Your money earns interest based on your balance.
- You can withdraw and deposit money – some limits can apply.
- As per monthly statement cycle, federal law allows only up to six transfers, either done electronically or through telephone. This limit is also referred to as the “Regulation D” by the Federal Reserve Board of Governors.The penalty for violating the Regulation D may vary in each bank or financial institution.
- Online savings accounts often have higher interest rates than those offered by brick-and-mortar banks.
Things to Consider First Before Opening a Savings Account
Steer clear from banks that require huge minimum balance on a monthly or yearly basis. Remember that in cases of non-compliance, you can find yourself paying a penalty which can be quite significant.
Most banks offer only a small interest rate but it is still wise to look for banks that offer better interest rates.
Transactions or Service Fees
Be properly informed about the transaction and service fees before you sign up for a savings account. Some banks levy extra charges on services and transactions without giving you prior notice.
Online Banking Services
Choose a bank that provides easy access to online banking services. This is very important especially if you are a busy person. You will save a lot of time and perhaps money too, by just making transactions online. Being able to make withdrawals and deposits using your mobile phone matters a lot in this time-and-task driven world.
ATM Center Accessibility
Check for the availability of ATMs in your area. Although you can use your ATM at most banks it could also mean paying extra charges. In order to save yourself from paying extra charges each time you use the ATM, choose a bank that provides greater accessibility to ATMs.
Debit Card Deals and Offers
Today, more and more banks offer value added services to lure more account holders. Ask about any debit card deals that the bank offers. These valued added services will vary from bank to bank. Some banks offer discounts at certain restaurants while others offer zero surcharge at gas stations. These services are important because saving a little money on each transaction could add up to a significant amount at the end of the month.
What is a CD (Certificate of Deposit)?
A Certificate of Deposit is sometimes referred to as a CD or Time Deposit. This type of account allows you to save money in a bank with a fixed maturity date and with a pre-set interest rate. Compared to savings account, CDs offer higher interest rates and a better opportunity for your money to grow.
The Early Withdrawal Penalty
Once you deposit your money in a CD, you will not be able to access your money until its maturity date. However, should you need to access it before the pre-set date of maturity you will be required to pay a financial penalty. This is the dreaded “early withdrawal penalty”. The total amount of the penalty will depend on the age of the CD and the institution that issued it. In most cases, the amount of the early withdrawal penalty equals to the pre-set amount of interest rate.
Certificates of Deposit are mostly issued by commercial banks. The money you put in your CD will be insured by the FDIC.
The certificate of deposit is usually issued electronically. It will also automatically renew upon its maturity date. When the maturity date is reached, the entire principal amount and its interest earned will immediately be available for the account holder to withdraw.
It is a safe option to invest your money since it has predictable returns that guarantee protection for your principal investment. CDs offer higher interest rate than any other money market accounts. People who wanted to build their own savings at a low-risk method will most likely prefer CDs than Savings or Checking account.
Advantages of CDs
- The first advantage of a Certificate of Deposit is that your funds are safe. It will be insured by the Federal Deposit Insurance Corporation. The FDIC insures CDs for up to $250,000. With a certificate of deposit, you will never lose your principal amount (the amount of your original deposit). In other words, CDs have a lower risk when compared to stocks and any other investments that are more volatile in nature.
- Compared with interest-bearing savings and checking accounts, CDs offer higher interest rates. The same is also true when you compare CDs with other money-market accounts.
- If you want better interest rates, opt to sign up in smaller banks. In most cases, smaller banks offer higher interest rates than bigger banks. Moreover, banks that offer online-only services also offer better interest rate because their costs are lesser than brick-and-mortar banks.
Disadvantages of CDs
- The first disadvantage of a Certificate of Deposit is that your funds are tied up for the duration of your certificate. You can learn more about duration below.
- Second, the fixed interest offered by CDs will increase your tendency of being locked into that same interest while other interest rates in the larger economy are already getting higher. This could mean a missed investment opportunity for you.
- If you think interest rates are increasing, you may opt for a no-penalty CD. This is the kind of CD that allows you to get your money back without the need to pay a penalty. However, you will have to wait at least 7 days before you will be able to get your money. This kind of CD still pays a higher rate compared to money-market. But, its interest rate is lower than the regular CD.
- Even if the interest rate of CD is high, it probably won’t be enough for you to keep up with the inflation rate. This means that chances are high that you will diminish your standard of living over a period of time if you only invest your money in CDs.
Whether you choose a savings account or a CD, make sure the bank where you put your money is FDIC insured. Account holders who deposit money in FDIC member banks will be granted federal deposit insurance of up to $250,000. This means that if for any reason your chosen bank goes out of business, you are still guaranteed to receive at least $250,000 of your money back. However, each bank may have a different $250,000 limit. This is why if you want to gain more than $250,000 on FDIC insurance, open accounts at several banks.
Things to Consider First Before Opening a Certificate of Deposit
The length of your CD term
You do not anticipate needing the funds you are depositing in a CD very soon – so it’s a good choice. But, you should carefully consider how long you want to tied up your money. Remember that you will pay a penalty if you withdraw the money before its maturity date. So, consider carefully how long you can really afford to keep your money in a CD account.
On the shorter end, you may choose a 6 or 12 month-term. However, CDs that have longer maturity dates such as a 10-year term can be a better way to slowly build your retirement savings because the longer the term, the higher the interest rate. But, if you are planning to have long-term savings goals but still want to obtain flexible access to your funds, you can choose to build your own CD ladder.
CD Account Rates
Shop around to know which banks offer higher CD account rates. This is very important because the rate determines how much you will be earning on your CD. Confirm the current CD rates offered by your bank before agreeing to any terms. You also need to ask about the compounding interest. This is also another good way of making sure your money will have a significant growth while it is still in the bank.
When shopping around for the best CD account rates, ask about the bank’s APY or Annual Percentage Yield. The APY will take into consideration how often the interest rate of your CD will compound. The more frequently it compounds, the higher returns you will yield at the end of your CD term.
Types of CDs
A traditional CD allows you to earn more money but only within a fixed rate. The good thing is that there are many other types of CDs that provide adjustable rates and other features that are more flexible. The different types of CDs include Bump Up, Callable, Indexed and Brokered. Know the differences between these CD types to make sure you sign up for one that is best suited to your financial goals.
If you withdraw your money ahead of your agreed end of term, you face the risk of paying an early withdrawal fee. Ask around which bank charges a lower withdrawal fee. This is because there may be times when you really need to withdraw your money even before it matures. The reason may not always be an emergency. But, paying for an early withdrawal penalty can also be advantageous if interest rates are suddenly increasing. It is best to withdraw it, pay for a penalty and then re-invest somewhere else where interest rates are higher.