Beyond Savings Accounts: CDs and Money Market Accounts

By April Dykman

When looking for a low-risk deposit account in which to stash your cash, you have a few options. Traditional savings accounts are one obvious way to go -- but don't forget about money market accounts and certificates of deposit (CDs), which are also popular choices but differ from savings accounts in important ways.

If you're wondering which one is right for you, here are the main differences -- along with the pros and cons of each type of deposit account.

Traditional Savings Accounts

A traditional savings account offers, on average, better interest rates than a checking account, with easier access to your money than a money market account.

"Traditional savings account" doesn't have to mean an account at your local bricks-and-mortar bank anymore. High-yield savings accounts are offered by many national, regional, and local banks online, and many allow you to take advantage of perks or promotional rates even if you are not a resident in the area. Some popular banks have an online presence only, which saves them money -- and those savings can be passed along to you in the form of better savings account rates.

Pros:

  • Good liquidity (access to your money), although there may be a short delay with some online-only banks
  • Most banks offer access online and through debit cards
  • Money is insured by the FDIC up to standard limits (currently set at a temporary limit of $250,000 per depositor in effect through December 31, 2013.  On January 1, 2014 this standard limit is set to return to $100,000 per depositor for savings accounts).

Cons:

  • Typically pay lower interest rates than other deposit accounts
  • Account rates fluctuate and vary from bank to bank, so you can be stuck with market-lagging savings account rates if you don't compare savings rates and keep tabs on what's offered

Money Market Account

A money market account is a longer-term, less liquid investment than a traditional savings account. The idea is that you'd park a sizable amount of money into the account and leave it there without constant transactions in and out of the account every month.

In return for less liquidity, you'll earn a higher interest rate, on average, than savings account rates. Basically, money market accounts can offer a better rate because funds deposited in the account are invested by the bank in low-risk instruments such as government T-bills. The higher returns are then paid out to the owners of the accounts.

Your money is not locked into the account, though. Many money market accounts make it simple to withdraw money, and some even allow you to write checks with which you can draw funds. There is usually a limit on how many transactions you can make in a month without incurring fees, so it's not a substitute for a daily-use checking account.

Pros:

  • It's easy to deposit money in a money market account.
  • Cash is available at any time.
  • This account type typically pays higher-than-average interest rates.
  • Your money is insured by the FDIC up to standard limits.

Cons:

  • The number of checks or account transactions you can conduct in a given time period may be limited.
  • Many accounts have minimum balance requirements -- some in the thousands of dollars -- to avoid monthly fees or even open the account.
  • The rate of interest offered sometimes increases or decreases as your account balance changes, making money market account rates more complicated to keep track of than savings account rates.

 

Certificates of Deposit

A CD is a savings certificate entitling the investor to receive interest in exchange for lending the banking institution money for a certain length of time. CDs have a predetermined maturity date and fixed interest rate. CD terms can range from one month to several years, with the highest interest rates going to the longest CD terms. CDs usually are insured by the FDIC up to the allowable limit.

Pros:

  • Since the interest rate is fixed, the investor already knows his or her earnings at the maturity date.
  • CDs are FDIC-insured up to standard limits.
  • If you can afford to lose access to your CD for a specified length of time, you can earn higher interest rates on average than with many money market accounts or savings accounts.

Cons:

  • CDs with longer terms and higher interest rates tie up your cash for longer periods of time.
  • The bank can take some or all of the interest that accrued, possibly with additional penalties, if you break the CD and withdraw the money before the CD matures.

Choosing the Right Deposit Account

Now that you know a little about each type of deposit account, you might be wondering how to choose the right one for your needs. Ask yourself the following questions when deciding on the right savings account:

  1. How accessible does your money need to be? Do you want to be able to withdraw it at any time? What withdrawal options do you want--ATM, checks, online, brick-and-mortar bank with human tellers?
  2. How much do you have to invest? If you don't have a large sum, a money market may not work for you. Eliminate options based on how much you plan to invest.
  3. What sort of return do you want, and how much liquidity are you willing to exchange for it? If you need the cash short-term, a 12-month CD is likely a poor choice. If you can afford to park the money untouched, however, you may get a better return with this kind of deposit.
  4. What rates can you get with each type of account? Sometimes high-yield savings accounts have better rates than short-term CDs, without the risk of penalty for early withdrawal. Don't think of the general trends in interest rates as absolutes, and shop carefully.
  5. What penalties are you willing to risk if you need your cash sooner than you planned? If you hate the idea of paying a penalty if you need to tap your savings, avoid committing your money in CDs.

Use these questions to help you choose a savings account, and be sure to check online for rate comparisons to get the best account rates and offers.