Having savings tucked away can give you financial peace of mind, but the question is, where's the best place to put your dollars and cents?
Certificates of deposit and savings accounts are two options for keeping your savings secure, while also earning interest on your money. Understanding how the two differ — and what they're best suited for — can help you decide which one to use as you work toward your financial goals.
How CDs Work
A certificate of deposit, or CD, is a savings certificate that's issued when you deposit money with a bank for a specific amount of time. The time frame can vary, with some CDs offering terms as short as 30 days, while others have terms of up to five years. Typically, the longer the term, the higher the interest rate.
Your deposited money, along with the interest you've earned, can be accessed once the CD reaches its maturity date. You can withdraw all of the funds in the CD, or roll it over into a new one for an additional term.
One thing to be aware of with CDs is the penalty for tapping your savings early. If you decide to withdraw some or all of your savings ahead of the maturity date, the bank may charge a penalty for doing so.
How Savings Accounts Work
Compared to CDs, savings accounts enable a smaller initial deposit and offer more flexibility in terms of when you can withdraw funds. While you can still earn interest on your deposits, you're not required to wait until a certain date to access your money.
You are, however, limited to making six withdrawals or transfers from a savings account each month by federal regulations. If you make a regular habit of making excess withdrawals, the bank could convert your savings account to a checking account. Other banks may charge an excess withdrawal fee if you go over the six-withdrawal limit. Some banks may close the account altogether.
When to Use a CD for Your Savings
There are a number of scenarios where a CD could be a better choice for hitting your savings targets, especially when you're planning for the long term. For example, you could use a CD to set aside money to pay for a wedding, buy a new car, or take a special vacation.
If you're thinking bigger, there are two goals in particular that a CD might be well-suited to help you meet.
1. Saving for a Home
If buying a home is in your plans, you'll need cash to cover things like your down payment, closing costs, moving expenses, and any new furniture or other items you may need to get settled in.
When you have a relatively long time horizon for saving (think a year or longer), an add-on CD may be a good fit. With an add-on CD, you make an initial deposit to get started and you can keep adding money to the CD, building up a bigger home purchase fund in the process.
2. During Retirement
A CD can also be a good choice in retirement if you desire a safe place to keep your money while enjoying a higher return than a regular savings account might offer. Creating a CD ladder can give you flexibility if you're concerned about not having access to cash when you need it. With a ladder strategy, you have multiple CDs with varying maturity dates. As one rung of the ladder matures, you have the option of withdrawing the cash or rolling it over into a new CD. If you plan your ladder correctly, you can have CDs maturing periodically so funds are available if needed, without facing any type of early withdrawal penalty.
When a Savings Account Could Make More Sense
CDs can be great when you need a place to park savings for long-term goals, but a savings account may offer more flexibility and convenience when you need money to cover current or short-term needs.
1. Saving for Rainy Days
Sixty-nine percent of Americans have less than $1,000 in savings and, if you're one of them, you may want to think seriously about building your emergency fund. Keeping three to six months' worth of expenses in a liquid savings account that's linked to your checking account can be a lifesaver when an unexpected financial blip pops up on the radar.
2. Taking Care of Your Home
While a CD can meet your savings needs before you buy a home, a money market savings account can help you plan for home ownership expenses after closing. Money market accounts offer competitive interest rates on deposits, along with access to your money via check or ATM, so if you need cash to pay for a home repair or to cover routine maintenance, you won't have to dip into your checking account or reach for a credit card.
Shop Around for the Best Savings Options
Whether you need a CD, a savings account, or both, it's important to do your research before choosing a savings vehicle. Compare the rates you can earn on deposits, the fees associated with each account, and how you can access your savings before making your final decision.