When individuals have plans to save their money, different options are available for them. They might first think of a simple savings account that allows your money to grow according to a set interest rate. You also have the option of choosing a money market account or a certificate of deposit (CD).

A money market account is like a mix of a savings account and a checking account. A CD, on the other hand, doesn’t offer much flexibility in accessing your money with a set term and withdrawal limits.

Money market and CD may seem interchangeable. They are both bank products offering low yields with maximum peace of mind. However, choosing between them ultimately depends on the specific objective you have for the cash and your need for liquidity.

Understanding the differences between the two is the key to determining which is the most appropriate vehicle for your needs. This article will help you understand them more fully.

• Which is Better a Money Market or CD?
• Can you Lose your Money in a Money Market Account?
• Are CDs a good investment in 2021?
• What are the Disadvantages of a Money Market Account?
• What are the Disadvantages of a CD?
• Why are Money Market Rates so low?
• Where Should I put my Money before the Market Crashes?
• What is Better an IRA or CD?

Which is Better a Money Market or CD?

To help you decide which of these options to chose from, let us consider some few details about the money market and CD and how they work.

How money market accounts work

A money market account is a safe place to stash your money at federally insured financial institutions. These accounts can pay you competitive interest rates that can boost your overall savings.

Read Also: What is a CD Ladder (and Should you have one)?

Money market accounts typically pay variable interest rates, which means the rate can rise and fall depending on market conditions. In general, these funds are accessible and make it relatively easy for you to tap your savings a few times each month.

There are generally limits to the number of times you can move money out of this type of account on a monthly basis. Typically, it’s six monthly withdrawals.

So, you’ll still have the option to use these funds several times each month and potentially more as the rules have relaxed in the midst of the coronavirus pandemic. Contact your bank directly to confirm its withdrawal and transfer rules.

A money market account can come with a debit card or a box of checks. With those tools, as well as the ability to transfer money deposited in your money market account to different accounts you hold at your bank, you can access your money whenever the need arises.

Overall, a money market account can give you a boost to your savings. Plus, you’ll be able to spend the funds whenever you need to.

How CDs work

A certificate of deposit, or CD, is another type of federally insured savings account that you can find at banks and credit unions. CDs pay a fixed interest rate. Longer-term CDs, such as 5-year CDs, tend to pay higher rates than shorter-term CDs, like 6-month CDs and 1-year CDs.

But unlike a money market account, you will not have access to your funds for a specific period of time. The bank or credit union tend to pay higher interest rates because you have agreed to lock up your money for a specific period of time, typically ranging from three months to five years.

In most cases, the CD will offer a guaranteed rate of return for the funds you place in the account. If you open a long-term CD, expect to receive a higher yield. If you open a short-term CD, then you’ll likely receive a lower interest rate.

No matter what term you choose, you’ll know exactly how much interest you’ll earn over the length of the CD when you sign up.

When Should you Choose a Money Market Account?

A money market account is a good way to grow your savings, but it is not the best fit for everyone. Here’s when it might make sense:

You want easy access to your funds

A money market account will allow you to spend or access the funds a few times each month or statement period. Although there are some monthly transaction limits (six withdrawals is often the max), you’ll be able to work within those guidelines to cover any emergency expenses.

If you’re considering stashing your emergency fund in one of these accounts, then the money market account is a better option than a CD because you can get at your money penalty-free if you need it.

You want these funds to grow

Money market accounts can have competitive interest rates. A higher APY can go a long way as you work to build your savings. A money market account, for example, can provide you with a better return than a traditional savings account.

If you have a short-term savings goal, then this extra boost is helpful — and you’ll still have access to your funds. For example, saving for an upcoming vacation in a money market account could be a good choice. The reason? 

You’ll be able to grow your savings more quickly without risking any of your principal, and you’ll also have the ability to pull the cash out when you’re ready to jet off on your adventure.

When Should you Choose a CD?

CDs can be a better fit in some cases. Here’s when it might be a good option for you:

You have a long-term plan for these funds

When you open a CD, you are choosing to lock your funds away for a specified period of time. Depending on the term you choose, it might range from a few months to several years. If you have a specific plan for these funds — and won’t need to tap the funds in an emergency —  then a CD might be a great fit.

For example, if you have plans to buy a house in five years, then a CD could be the right place to store your down payment. You’d be able to take advantage of the most competitive interest rates and have access to the funds when you are ready to purchase your home.

Plus, you won’t have to worry about losing money like you would if you invested in stocks or other types of non-guaranteed investments if the market tanks.

You want these savings locked away

Saving money can be difficult. If you struggle to keep from spending your savings account, then a CD could be a good choice. You won’t be able to touch the funds for the entire term, unless you’re willing to pay an early withdrawal penalty.

That should keep your savings protected from a last-minute sale at your favorite store. Plus, your savings will be growing through the term.

CD vs. Money Market Account: Which Is Better?

Comparing money market accounts and CDs overall isn’t entirely fair since they are structured so differently, so let’s break it down.

Money market accounts are better than CDs if you’re looking for a more accessible account. You can easily deposit and withdraw funds to and from a money market account with an ATM card, personal checks, online or on mobile.

Again, also double-check whether a bank issues ATM cards or personal checks with their money market accounts. Your main limitation will be the six allowed outgoing transactions per statement cycle.

CDs, on the other hand, are all about limiting access to your money. Once you open an account and make your initial deposit, you cannot move money in or out of the account without facing a heavy penalty. This may help you though, if you’re prone to spending and not saving. If that’s the case, a money market account may give you too much freedom.

When it comes to interest rates, money market accounts may be your better bet. MMA rates are typically higher than basic savings accounts and short-term CD rates. CDs can have higher rates than a money market account, but those are often the long-term accounts from two years and upward.

That means that to snag a CD rate that’s higher than a money market account rate, you’ll most likely have to wait a couple years to have access to that money.

Can you Lose your Money in a Money Market Account?

Money market accounts are generally a safe investment. For one thing, they are insured by the Federal Deposit Insurance Corporation (FDIC). The independent agency insures deposits up to $250,000 per depositor for member firms. If the bank or institution fails, your investment will be covered.

Another reason why these accounts are relatively safe is that they come with very low risk. That’s because banks use the money from these accounts to invest in stable, short-term securities that come with low risk and are highly liquid including certificates of deposit (CDs), government securities, and commercial paper. Once these investments mature, the bank splits the return with you, which is why you end up getting a higher rate.

Are CDs a good investment in 2021?

Examining the current economic conditions and your personal financial situation can help you determine whether a CD is a worthwhile investment. The ultimate allure of a CD is its certainty. 

Because the rate is fixed, it takes the guesswork out of what future earnings will look like. Plus, most banks pay higher rates on CDs than they do on savings accounts.

For those who live paycheck to paycheck and want to make some additional money through investing, however, CDs might not be the way to go. 

CDs require you to lock up your money for some time, so pulling the money out early can have consequences. While a CD does act much like a savings account, you will not have access to it early without paying some sort of penalty.

Understanding the mechanics of investing in a CD can help you both plan and determine whether this type of investment is right for you.

If your ultimate goal is to build up your savings while still being able to take care of emergencies, CDs can take out a lot of the guesswork surrounding your financial future. CDs are worth it when you’re seeking a virtually risk-free investment that you can count on.

What are the Disadvantages of a Money Market Account?

An individual money market account is insured up to $250,000 if you choose a bank or credit union covered by the National Credit Union Administration or the Federal Deposit Insurance Corporation. Don’t confuse this type of account with a money market mutual fund, which isn’t insured.

A money market account often pays higher interest than a savings account, while allowing some check writing. Despite these advantages, money market accounts also have disadvantages.

Limited Transfers and Checks

A money market account has a major disadvantage for regular monthly bill-paying. You are allowed only six electronic transfers each month, with a maximum of three of these by debit card or check, according to Bankrate.com.

There’s normally no limit on the number of withdrawals you can make in-person, by mail, or by an automatic teller. However, if you pay a lot of bills every month, you still need a checking account.

Variable Interest Rate

Money market account interest rates are often tiered, which means they depend on the balance in your account. For this reason, you usually qualify for the highest rate only if you have $10,000 or more on deposit. The interest rate on a money market account also fluctuates, without a guarantee for any period of time.

If market interest rates fall, the bank or credit union can reduce your rate. A money market account doesn’t safeguard your rate like a certificate of deposit, which normally pays a guaranteed rate until it matures.

Taxes and Inflation

Whatever interest you earn in a money market or other bank account is reduced by federal income taxes. Inflation also reduces the buying power of your money if the interest rate is less than inflation.

According to Bankrate.com writer Don Taylor, it often pays to put some of your money in a CD with higher interest even if you have to pay an early withdrawal penalty.

Minimum Balance and Fees

Money market accounts usually require a higher minimum balance than regular savings accounts, sometimes as much as $10,000, according to Bankrate.com. You can be hit with a hefty fee of as much as $25 if your balance falls below the minimum.

You can incur a penalty for writing too many checks. Some banks or credit union may also charge other fees, such as for exceeding a certain number of automatic teller withdrawals.

Free Access

A money market account is a poor vehicle for many people to save for long-term goals. Because it doesn’t have a set term and allows access to your money, it doesn’t reinforce your will power.

This is a disadvantage if you are subject to impulse purchases. On the other hand, a certificate of deposit ties up your money for a set term, and the early withdrawal penalty provides an incentive to leave your savings alone.

What are the Disadvantages of a CD?

1. Early withdrawal penalties

You might think of a CD as essentially locking up your money and throwing away the key. And this perception is true to an extent: it is typically harder to get your savings out of a CD, and in most cases (unless you have a no-penalty CD), you’ll get hit with an early-withdrawal penalty if you take your money out before the CD’s term is up.

In short, though, this penalty simply means that traditional CDs aren’t the best option for short-term savings goals, such as building an emergency fund. The whole point of a CD is to safely let your existing savings grow over time. That’s why CDs are great options for future savings goals, such as starting a business or buying a house.

Note: If you are still worried about locking your money away, you can always choose a no-penalty CD. The interest rates are normally a bit lower for these types of CDs and there are restrictions on when you may early withdraw or terminate your CD, but you can access your savings if absolutely necessary without paying a penalty fee.

2. Interest rate fluctuations

What do we mean by fluctuation? Well, interest rates go up or down, depending on how confident the U.S. Federal Reserve is about the economy. So if interest rates go up, a CD’s fixed interest rate works against you because you’re locked into the lower rate.

Now, if you’re worried about that, you could consider opening a high-yield savings account so your savings will get the best interest rates if rates go up. But then you risk not making as much money if the rates go down. It’s definitely a trade-off that you have to think about.

3. Lower returns compared to things like high-yield checking account

The money you make on CDs is normally better than traditional savings accounts, but perhaps lower than you could earn from other saving solutions such as a high yield checking account.

But here’s the thing: this type of savings option is normally meant for hitting more immediate savings goals like an emergency fund or upcoming purchases, as well as managing your finances; a CD is designed to be a place where you can park your money, earn interest, and feel less tempted to spend your savings so you can achieve future savings goals.

Why are Money Market Rates so low?

The U.S. Federal Reserve and terrible disasters are the two main causes of decreases in the interest rates on money market investments. The Fed lowers short-term interest rates to spur the economy out of recession.

Disasters lower short-term interest rates because investors take their money out of other investments, such as stock, and put it into the safest investments they can find. These are the shortest investments, which include U.S. Treasury bills, bank certificates of deposit and high-grade commercial paper.

Considerations

The Federal Reserve Act of 1913 created the U.S. Federal Reserve Bank with a mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” The way the bank has complied with this mandate is through Federal Reserve monetary policy and Federal Reserve open market operations.

A booming economy tends to increase inflation because every consumer, bank and corporation borrows money. The more money borrowed, the more the nation’s money supply grows.

Inflation occurs when there is so much money available in the system that it overwhelms the available supply of goods to buy. Goods become more scarce compared with money, and prices rise.

When Rates Rise

The Fed must keep prices stable, so it adopts a restrictive monetary policy. This removes money from the system by raising interest rates and selling Treasury securities in the open market.

It also removes money from the system by raising the requirements for the amount of money banks must hold in reserve to back any defaults as a result of their lending activities.

The Fed raises rates by increasing the discount rate, which is the rate banks pay at the Fed discount window to borrow money to meet their higher reserve requirements.

If the banks are paying higher rates to back their lending, they pass on those rate increases to their customers in the form of higher rates on loans. Higher loan interest rates, in turn, slow the growth of the economy by making money more expensive, which also restricts the money supply.

As loan rates rise, the interest rates on bonds, bills, and notes increase to attract investors’ money. This is when your money market fund pays high-interest rates.

When Rates Fall

When the economy cools so much it begins to fall into recession, the Fed adopts an expansionary monetary policy. It lowers interest rates by lowering the discount rate and bank reserve requirements. Banks now have more money to lend because they don’t have to keep so much in reserve, and they lend it at lower interest rates.

Consumers and corporations start borrowing again, and this increases the supply of money in the system. Interest rates on all maturities decline because it is no longer so difficult to attract investors’ money. This is what happens when your money market rates decline.

Times Of Crisis

Short-term securities, those with maturities under one year, are called money markets because they are where consumers and corporations tend to keep their extra cash. Securities that mature in three-months or less are actually considered cash equivalents because they are highly liquid and very secure in terms of investment safety.

This element of safety is also why money pours into these securities from investors seeking safety for their money during times of crisis. When the Fed adopts an expansionary monetary policy, the first rates affected are the shortest ones.

For example, between the Fed and uncertain times, money market rates dropped so low they were nearly imperceptible after the 2008 credit crisis.

Where Should I put my Money before the Market Crashes?

When unemployment reaches high levels and foreclosures are commonplace, it’s natural to worry about the economy and your investments.

If most of your money is in the stock market and it crashes, you might not have time to wait for a possible recovery. Several options exist besides the stock market. If you think a crash is likely to occur, you might want to look into some of them.

TIPS

You can buy Treasury Inflation-Protected Securities from the U.S. Treasury or from a bank or broker to provide you with some protection against inflation. Your principal would increase with inflation and decrease with deflation. This is measured by the Consumer Price Index.

You can buy a TIPS that matures in five, 10 or 30 years. Interest is paid twice a year and is applied to your principal. At the time of maturity, you receive whichever is greater between your adjusted and your original principal.

Precious Metals

Invest in precious metals — gold, silver, platinum and palladium — if you are concerned about the dollar losing value. People historically have held precious metals as a way to diversify their portfolios.

A popular saying used in many advertisements is that the price of metals fluctuates but never drops to zero — a come-on, yes, but one that contains some truth.

You can invest in precious metals by buying stock that holds shares in mining companies, by buying exchange-traded funds that hold bullion or by buying coins — both antique and newly minted ones.

Foreign Currency

If you are concerned about the dollar being weak, you might want to invest in foreign currency. If you choose the wrong currency, however, you could lose money if it drops below the dollar. You have the option of investing in many different foreign currencies to hedge your bets.

Investing in foreign currency is risky, so you need to gauge your risk tolerance. It’s best to work with a financial intermediary, said Carl Resnick, a Rydex SGI portfolio strategist, in Bankrate.com.

Savings Accounts

Put your money in savings accounts and certificates of deposit if you are worried about a crash. They are the safest vehicles for your money.

The Federal Deposit Insurance Corp. and the National Credit Union Administration insure your money in savings accounts, checking accounts, certificates of deposit and money market deposit account up to $250,000 per depositor, per bank.

What is Better an IRA or CD?

If you’ve already maxed out your retirement contributions through your employer’s plan or you’re not eligible to participate in a plan at work, an individual retirement account (IRA) may be your best bet. IRAs are typically categorized as traditional or Roth accounts but there’s also a third option in the form of an IRA CD.

This particular savings vehicle combines certain features of an IRA with a certificate of deposit. There are advantages and disadvantages associated with each option so it’s important to understand how they work when making your choice.

Traditional IRA

A traditional IRA allows you to save for retirement on a tax-deferred basis and some or all of the money you put in may be tax-deductible. The IRS caps the amount you can put into a traditional IRA each year.

For 2019, the contribution limit is $6,000 plus an additional $1,000 for savers over age 50. The contribution limits are the same in 2020.

Generally, you can open a traditional IRA as long as you’re under age 70 1/2 and have taxable income from working. There are no income restrictions on who can contribute but your income does factor in to what amount of your contributions, if any, you can deduct. Whether or not you’re covered through an employer’s retirement plan also has an impact.

For 2019, single filers covered by an employer’s plan could deduct the full amount of their contribution if their adjusted gross income is $64,000 or less. The AGI limit for married couples filing jointly is $103,000 or less and $123,000 or less if you’re married and file separately.

If you’re single and not covered by an employer’s plan then no AGI limit applies but married couples are subject to a cap of $203,000 or less when one spouse is covered through their workplace. In 2020, single filers will need AGIs of $65,000 or less, and married couples filing jointly will need between $104,000 and $124,000.

Generally, you won’t owe taxes on the money in a traditional IRA until you start making withdrawals. Penalty-free withdrawals are only allowed after you reach age 59 1/2.

If you take the cash out before then you’ll have to pay taxes on the money along with a 10 percent early withdrawal penalty. Once you turn 70 1/2, you’re required to begin taking minimum distributions or face a much stiffer tax penalty.

Roth IRA

The Roth IRA is a relatively new retirement savings vehicle that was introduced as an alternative to the traditional IRA. A Roth IRA is funded with after-tax dollars, which means that you won’t get a deduction for your contributions but you won’t pay any taxes on qualified withdrawals.

The annual contribution limits for a Roth account are the same as a traditional IRA. Unlike a traditional IRA, Roth savers must meet certain income guidelines in order to open this type of account.

Read Also: Investing for Retirement: The Complete Guide

For 2019, single filers with an adjusted gross income of $122,000 or less are eligible to chip in the full amount. Married couples earning $193,000 or less annually are also able to put money into a Roth IRA.

For 2020, single filers with an income of $124,000 or less are eligible. Married couples are eligible as long as they have less than $196,000.

Generally, you can take money out a Roth tax- and penalty-free if your account has been open for at least five years and you’re age 59 1/2 or older. If you withdraw money before age 59 1/2, the earnings are subject to tax and you’ll also get hit with the early withdrawal penalty.

There are exceptions to this rule if you’re using the money to purchase a first home, to pay for qualifying medical expenses that exceed 10 percent of your gross income or you become totally and permanently disabled. There are no minimum distribution requirements with a Roth IRA.

IRA CD

When you invest in a certificate of deposit, the money earns interest over a set period time, which may be a few months or a few years depending on the CD. Once the CD matures, you can take the money out or roll it over for a new term. If you cash out a certificate of deposit early you’ll typically have to pay a penalty.

An IRA CD works in a similar way, with your money growing on a tax-deferred basis inside a retirement account. Your initial investment earns a fixed interest rate over a set timeframe and renews automatically.

The more money you put in, the higher your rate will be which means a bigger return on your investment. The main difference is that unlike a regular CD, an IRA CD offers certain tax advantages that are associated with a traditional or Roth IRA.

With an IRA CD, you’re subject to the same limitations on contributions and withdrawals as you would be with a traditional or Roth IRA. If you decide to take the money out early the same taxes and penalties would apply.

You should also keep in mind that investing in an IRA CD counts towards your total annual IRA contribution limit.

In terms of security, an IRA CD offers a safer investment since your interest rate is not subject to fluctuations in the market. CDs are insured by the FDIC for up to $250,000 so if your bank goes under you’ll be protected up to the federal coverage limits.

Finally

Choosing the right retirement savings vehicle requires a careful evaluation of your income, current tax situation and your long-term outlook. If this all seems overwhelming, don’t hesitate to work with a financial advisor to get your retirement savings on track.