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What’s the Difference Between Money Market Accounts, CDs and Savings Accounts?

You’ve found a way to save some money, but now you have to decide where to put it so it’s ready when you need it. That’s a good problem to have.

Three of the most popular short-term options offered are savings accounts, money market accounts, and certificates of deposit (CDs). All of these types of accounts are offered by banks that are federally insured, making them the safest possible place to put your savings.

Let’s take a look at these three types of accounts, and then see which one is right for you.

Savings Accounts

This is a deposit account held by a bank that earns interest. Typically, a bank will offer a relatively low rate of interest, currently between 1%-2% for these accounts, and it may restrict the number of withdrawals. Also, the interest rate you receive can go up or down over time, along with the interest rates that are set by the Federal Reserve. Some savings accounts offer debit cards to allow you to withdraw money using an ATM or an electronic transfer. A savings account may also require you to maintain a minimum balance to avoid a monthly fee, but it’s often a low amount.

Advantages

  • Unlimited withdrawals.
  • Low minimum balance requirements.
  • Low or no fees.
  • Access to ATMs.
  • Compatible with electronic transfers.
Disadvantages

  • Very low interest rates.
  • Limited number of withdrawals per month.

Money Market Accounts

This is a deposit account offered by a bank, and it’s similar to a savings account. As the name suggests, the major difference is that the funds are invested in many types of instruments in the financial markets and the interest rate is higher. Like a savings account, money market accounts also come with a limited number of withdrawals per month, making them less liquid (accessible) than a checking account. You are also more likely to have a higher minimum deposit amount than a checking account.

Advantages

  • Relatively high rates of interest compared to savings and checking accounts.
  • Ability to write checks, make ATM withdrawals, and perform electronic transfers.
Disadvantages

  • High minimum deposit required to avoid monthly fees.
  • Limited number of withdrawals per month.

Certificates of Deposit (CDs)

CDs are similar to savings accounts in many ways, but with a few important differences. To purchase a CD, you must meet a minimum amount, and not make a withdrawal from the account for a specified length of time. For example, you might purchase a three-year CD with a $1,000 minimum deposit that returns 1.9% Annual Percentage Yield (APY). In this example, the $1,000 CD will be worth $1,058 after three years, when it’s considered to be “mature.”

While a CD will typically have a higher interest rate than a savings account, and sometimes even money market accounts, it will also have a penalty for making a withdrawal before maturity. Once the CD’s term is complete, you will have the option to withdraw the money, or roll it over into another CD.

Advantages

  • Higher interest rates than savings accounts.
  • The interest rate doesn’t change during the term of the account.
  • No fees when you hold your account to maturity.
Disadvantages

  • Penalties for early withdraw make your money less liquid.
  • No access to your deposit through checks, ATM transactions, or electronic transfers.

How to choose the right account for your needs

Of these three types of accounts, savings and money market accounts are the most similar. A savings account will make the most sense for those who have a relatively small balance, and want to avoid paying unnecessary fees. For example, savings accounts are often the first bank accounts that children open with the help of their parents in order to teach them how to save their money. A savings account can also be a great place to earn a little bit more interest on your money when you find yourself with continuously high balances on your checking account.

Savings accounts can also be right for those who aren’t too concerned about earning interest at the most competitive rates. At the same time, savings accounts still allow you to use an ATM card or electronic transfers to make withdrawals. However, you should look closely at the fees for using an ATM as well as the account’s minimum balance requirement, and any fees for going below it.

But when you have a larger amount of money that you need ready access to, a money market account can be an even better choice than a savings accounts. These accounts will offer higher interest rates, yet still allow access to your funds through checks, ATM transactions or electronic transfers. You just have to make sure that you will be able to continuously meet the minimum balance requirements in order to avoid costly fees, which will negate the additional interest earned. You should also learn how many withdrawals are allowed per month, and what the fees are if you need to make additional withdrawals.

Finally, certificates of deposit offer an alternative way to save your money. These accounts are for those who know how long they will need to save their money, and are willing to trade easy access to their money for the increased interest they can earn with this type of account. You should always keep in mind that the penalties for an early withdrawal will require you give up all or much of your interest.

Bottom line

We are fortunate to have a banking system that offers three different types of deposit accounts that are each eligible for federal deposit insurance, up to $250,000 per account. By understanding the advantages and drawbacks of each type of account, you can choose the best one for your needs.

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