If the economic crisis has taught us anything, it’s to not expect the same interest rates we have in previous years. The message has been that expectations should be lowered and the worst should be expected. Take, for example, 401(k) plans. Previously, these investments were earning around 10% each year. Now, investors might be lucky if they don’t lose money.
Investors also need to lower their expectations for certificates of deposit (CD) and savings accounts. As of November 2010, the average interest rate for 12-month CDs was pegged at 0.82%. This is a far cry from the 1.79% average interest rate from 2009, then considered a steep drop from previous years. To make matters worse, improvements are not expected to happen anytime soon. Everywhere you look, interest yields are incredibly low or negative. The Federal Reserve also wants to keep interest rates low to keep the money flowing through the economy.
These developments do not mean you should stop saving. On the contrary, saving has never been more important than now. The market is highly unstable today. It is still recommended you put money into low-risk investments such as CDs and savings accounts. As with any type of bank account, the trade-off between a CD and a savings account involves the rate and accessibility of the funds. So in the match CDs vs. savings accounts, which comes out on top?
In general, a savings account provides easy access to funds. The main downside is that you earn very minimal yields from savings account. Different institutions provide various ways to access the funds. You need to determine if it is easy to withdraw the funds from your bank before opening the account.
Certificate of Deposit
Meanwhile, a CD limits your access to the funds. Basically, the account provides higher interest yields in return for the loss of fund mobility. If you need to withdraw your money before the maturity date, you may incur penalty charges. There are also certain banks that won’t allow you to access your funds before maturity. A good way to get around this is to “ladder” your CDs so certain amounts mature more quickly than others.
It is recommended to invest in a CD only money you know you will not need in the near future. In addition, it is important to determine if the extra interest is worth locking your money in this investment for a certain time frame. Depending on the length of your investment, the bank might offer different rates. The Federal Deposit Insurance Corporation (FDIC) insures CDs, just like it does savings accounts. In the event that your bank collapses, you will enjoy a certain level of protection from the government.
Should You Invest in a CD or a Savings Account?
Both options allow you to enjoy compounded interest. Essentially, the interest you earn is added to the account. The next interest payment you receive comes from the principal and the interest yield from the previous month. As was mentioned earlier, the two main considerations include the interest rate and the ease of access to the funds.
In general, you should invest in CD if you have a certain amount of money you will not need in the foreseeable future. Investing in CDs is better, in terms of monetary compensation, simply because of the higher yield it provides. At the same time, savings accounts can also be considered as a good alternative for individuals who need quick access to their funds in the foreseeable future. Ultimately, it is up to you to determine which option is better for your unique circumstance.