There's really no simpler bank account option for your savings than a savings account. Yes, stashing some cash under your mattress is easier -- but you won't earn any interest, and your money won't be protected. But if you open a savings account, you'll earn interest and have the peace of mind that comes from knowing your money is safe in the event of bank failure (assuming your bank has FDIC insurance).
But savings accounts come with one big pitfall when you compare them to their cousin, the certificate of deposit (CD). Let's take a closer look at the downside of relying exclusively on a savings account -- rather than diversifying by opening a CD, too.
Rates -- fixed or variable?
There are a few big differences between CDs and savings accounts, and the type of interest rate they come with is one of them. Specifically, savings account APYs (annual percentage yields) are variable and subject to change at any point. I opened a high-yield savings account with an online bank in early 2022, and I have received multiple emails from the bank informing me of changes to my rate. Over this period of time, they've all been increases, and this makes sense.
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The Federal Reserve addressed sky-high inflation in 2021 and 2022 by increasing the federal funds rate. This doesn't directly inform rates on consumer bank accounts and loans, but they tend to trend in the same direction. The federal funds rate is predicted to fall this year, and when it does, I expect to start getting emails from my bank with the news that my savings account's APY is dropping, too.
But the cool thing about CDs is that when you open one and deposit your cash, you're getting to lock in the CD rate you started with. If you open a 1-year CD with an APY of 5%, you'll earn that 5% over the entire year. If that CD holds $5,000, that equals $250 earned on your money. Over that same year, the rate on your savings account might fall -- but your CD's rate won't.
When is a CD a good idea?
You're probably thinking, "Great! I'll put all my savings into CDs and lock in those high rates." And that may be a great choice. While a CD isn't the perfect solution for all savings situations, it really shines for one in particular.
If you've saved money for a sizeable expense that you'll be incurring in the next few years (such as a down payment on a house purchase, a wedding, or perhaps your child's first year of college), a CD can be a good place to keep it safe and earn a predictable return. The key is to be sure that you really can leave the money alone for the duration of the CD term, as you'll incur early withdrawal penalties if you need to pull your money out sooner.
When is a savings account a better option?
A savings account, on the other hand, is best used for money you'll need soon but that doesn't have a set timeline. This includes your emergency fund -- a CD is a terrible place for that.
Imagine that you have $10,000 in the bank for unplanned expenses, and you need $2,500 of it for a home or car repair. If you have that money in a CD, you'll have to pay a penalty to break your CD term, which means losing part of your interest earnings (or even part of your principal, depending on how long the CD has been open and how long the term is) in the process. But if it's in a savings account (or possibly even a money market account), you can access it without penalty.
A savings account is also a great fit for people who are still actively saving. You generally can't add more money to a CD once it's open, but you can make contributions to a savings account anytime you please.
Now that you know the benefit of CDs over savings accounts (particularly in this high interest rate environment), you might want to take some time to decide if they fit into your savings strategy. If they do, it's a good idea to open one sooner rather than later -- before rates fall.
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FAQs
A certificate of deposit offers a fixed interest rate that's usually higher than what a regular savings account offers. The tradeoff is you agree to keep your money in the CD for a set amount of time, typically three months to five years.
Why shouldn't you invest all of your savings in a CD? ›
Banks and credit unions often charge an early withdrawal penalty for taking funds from a CD ahead of its maturity date. This penalty can be a flat fee or a percentage of the interest earned. In some cases, it could even be all the interest earned, negating your efforts to use a CD for savings.
Is it risky to put all your money in a savings account? ›
The main issue is that the money is instantly accessible if you need it. And there's virtually no risk of losses if the money is in an FDIC-insured bank account. If you don't have an emergency fund, you should probably build one even before putting your savings money toward retirement or other goals.
What are two drawbacks of putting your money in a CD? ›
CD rates may not be high enough to keep pace with inflation when consumer prices rise. Investing money in the stock market could generate much higher returns than CDs. CDs offer less liquidity than savings accounts, money market accounts, or checking accounts.
Why would you choose the savings account over the CD? ›
Deciding between CD or savings account
When to consider a savings account: You need the money to be accessible, like an emergency fund. You're saving for a smaller or relatively short-term goal. You're primarily putting money aside instead of trying to grow it.
Why should you deposit $5000 in CD now? ›
Unlike traditional or high-yield savings accounts, which have variable APYs, most CDs lock your money into a fixed interest rate the day you open the account. That's why if you suspect that interest rates will soon drop, it can be a good idea to put money in a CD to preserve the high APY you would earn.
Are CDs safe if the market crashes? ›
Are CDs safe if the market crashes? Putting your money in a CD doesn't involve putting your money in the stock market. Instead, it's in a financial institution, like a bank or credit union. So, in the event of a market crash, your CD account will not be impacted or lose value.
What is the catch with putting your money in a CD? ›
A CD is similar to a traditional savings account, but your bank will pay you a higher interest rate in exchange for locking your funds away for a set amount of time. The catch for that extra earning potential? Most CDs will charge you a penalty if you need your money before the end of your term.
Can CD accounts lose money? ›
Key Takeaways
Standard CDs are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000, so they cannot lose money. However, some CDs that are not FDIC-insured may carry greater risk, and there may be risks that come from rising inflation or interest rates.
Where do millionaires keep their money? ›
Many millionaires keep a lot of their money in cash or highly liquid cash equivalents. They establish an emergency account before ever starting to invest. Millionaires bank differently than the rest of us. Any bank accounts they have are handled by a private banker who probably also manages their wealth.
Upon receiving a large sum of money, the immediate question is where to store it to earn interest or get a good return on your investment. A savings account is a common choice, offering a secure place to keep your money while earning a decent rate.
How many people have $3000000 in savings? ›
There are estimated to be a little over 8 million households in the US with a net worth of $3 million or more.
What happens to CD if the bank closes? ›
The FDIC Covers CDs in the Event of Bank Failure
CDs are treated by the FDIC like other bank accounts and will be insured up to $250,000 if the bank is a member of the agency. If you have multiple CDs across different member banks, each will be protected up to that limit.
Can CDs be inherited? ›
Some CD accounts allow the owner to name a payable-on-death (POD) beneficiary. If the account owner dies, this person will automatically inherit the funds in a CD. These banks may terminate a CD when the account owner dies and allow the POD beneficiary immediate access to these funds.
Should I put all my money into a CD? ›
While CDs can provide some guaranteed returns over time and some level of security, they're not likely to provide you the returns needed to build wealth for retirement over time. Instead, it might make more sense to build wealth with other assets and only use CDs for a portion of your portfolio.
Are CD accounts worth it now? ›
While CDs can provide some guaranteed returns over time and some level of security, they're not likely to provide you the returns needed to build wealth for retirement over time. Instead, it might make more sense to build wealth with other assets and only use CDs for a portion of your portfolio.
Do you pay taxes on CD interest? ›
Key takeaways. Interest earned on CDs is considered taxable income by the IRS, regardless of whether the money is received in cash or reinvested. Interest earned on CDs with terms longer than one year must be reported and taxed every year, even if the CD cannot be cashed in until maturity.
Is a CD better than a savings account for a child? ›
Which one is the best depends on the ultimate use of the funds. CDs are lower-risk, they are federally insured up to $250,000, and they may offer higher interest rates than regular savings accounts. However, other options to consider are a 529 college savings account and a Roth IRA.
Is a CD safer than a money market account? ›
Both money market funds and CDs are considered relatively safe investments, potentially providing returns in the form of interest or dividends. Money market funds are generally more liquid than bank or brokered CDs.
