A CD, or Certificate of Deposit, is a less liquid savings and investment vehicle compared with a traditional savings account. In return for pledging money in a CD and accepting the obligation to not withdraw it, the investor is promised a higher yield. However, there is a wide variation in interest rates and APY for both CDs and savings accounts. So it is wise to comparison shop; it is not hard to find online savings accounts where the interest rate is close to that offered on 1-year CDs.

Comparison chart

Certificate of Deposit versus Savings Account comparison chart
Edit this comparison chartCertificate of DepositSavings Account
Introduction A certificate of deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions. Saving accounts are accounts maintained by retail financial institutions that pay interest but cannot be used directly as money in the narrow sense of an exchange. Customers can set aside some assets while earning interest.
FDIC insured Yes (up to $250,000) Yes, $100,000 to $250,000 per depositor.
Average one-year return (U.S.) 0.44% 0.35%
Withdrawals Only after maturity At any time; sometimes funds cannot be withdrawn until 7 days after they are deposited into the account
Additional deposits Not permitted; the principal amount for a CD is fixed at the beginning Yes, more funds can be deposited into a savings account at any time.
Checks No No
ATM card No Usually not, but some banks may offer a convenience card.
Withdrawal Restrictions Penalty for early withdrawals. Partial withdrawals not allowed; the entire balance must be withdrawn in one go. Typically 3-6 withdrawals a month. Allowed to withdraw only a portion of the account balance.
Minimum Balance Sometimes; varies by bank Sometimes; varies by bank
Designed For Saving money risk-free for the medium- to long-term Saving money risk-free for short- or long-term
Fees Usually there are no fees for opening a term deposit. There may be fees for early withdrawal. Sometimes, varies by bank
Interest Earned Yes, but amount varies wildly by bank or credit union Yes, but amount varies wildly by bank or credit union
Access No access to funds without terminating the deposit To use money, account holder must first transfer it to checking account (usually)
Other Features None No facilities other than internal online transactions with some banks (i.e., transfer from savings to checking)
Interest Rate 0.1% - 2% depending upon the term duration of the CD. 0 .1% - .5% (but online-only banks can offer up to 1%).
Access to funds None without terminating the instrument Limited

What is a Certificate of Deposit?

A Certificate of Deposit — also called a CD, term deposit, non-liquid account, or simply a certificate — is a financial instrument where the investor agrees to loan a fixed amount of money for a fixed duration to a banking institution. The interest rate offered by the bank varies depending upon the duration—or term—of the CD. Short-term CDs — those with a term of 6 months or 1 year — have the lowest interest rates. As the term gets longer, interest rates rise; this is usually done in chunks e.g., a different interest rate would apply to each slab in the following ranges: 6-12 months, 12-24 months, 24-36 months, 3-5 years.

What is a Savings Account?

A savings account with a bank or credit union lets a depositor keep liquid funds with a financial institution and earn an interest rate that is typically higher than a checking account. In return, the depositor accepts some limits to when and how often the funds in the account can be withdrawn.

Interest Rate

For investors looking for a safe way to park funds, choosing between a CD and a savings account often boils down to which option generates a higher yield. i.e., pays a higher interest rate. In general a CD is less liquid and so it compensates the investor via a higher yield when compared with a savings account.

However, the interest rate offered by some financial institutions can be several times that offered by some large banks. For example, as of May 2016, Bank of America's CD products offered APYs ranging from a measly 0.01% for a risk-free CD to 0.15% for a 4-year CD. At the same time, the yield on Alliant Credit Union's CDs range from 1.15% APY for a 12-month CD to 2.05% APY for a 5-year certificate.

Websites like BankRate are great for finding reliable financial institutions that offer high APYs. Online accounts like Ally Bank, EverBank and Alliant Credit Union tend to offer the best rates.

Withdrawal Restrictions

CD withdrawal restrictions

With a CD, there is almost always a penalty for early withdrawal. So it is best to only invest funds in a CD when you are certain that you won't need the funds any time soon. The best CD products limit the penalty to a portion of the interest earned, so that you never lose your principal no matter what. For example, Alliant Credit Union's term deposits have the following rules for calculating the penalty for early withdrawal:

For 24-60 month CDs: dividends earned for the number of days the certificate is open (up to max of 180 days of dividends)

There are some exceptions to the penalty. For example, if the account owner dies and the funds in the CD need to be withdrawn by the estate, the penalty is waived.

Restrictions in a Savings Account

Restrictions for savings account vary by bank and account tier. Some savings accounts mandate that once funds are transferred into the account, they must stay in the account for a specific period—e.g. 7 days—before they may be withdrawn. In addition, some banks also impose limits on the number of transactions per month for a savings account in order to discourage too many withdrawals. The account type banks prefer their customers use for day-to-day transactional activity is the checking account.

Risk and Safety

Savings accounts and term deposits are among the safest of investments. Their yield is low compared to riskier asset classes like stocks or even bonds. But while there is a risk of losing your principal when you invest in stocks, mutual funds, municipal or corporate bonds, there is no such risk when you put your money in a savings account. Depending upon early withdrawal penalty rules, there may be some risk in a CD but usually the penalty is restricted to a portion of the interest earned; the principal is usually safe.

Always check if the accounts are insured; if it's a bank the insurance will be through FDIC and if it's a credit union the insurance will be via NCUA. In both cases, funds are insured up to $250,000 per account.

Laddering

Laddering is a concept that allows investors to benefit from the better yields of longer term CDs without completely sacrificing liquidity. Laddering means investing in several smaller CDs with staggered maturity dates instead of investing a large lump sum amount in one long-term CD. For example, say you have $10,000 to invest in CDs. Investing the entire amount in one 5-year term deposit would lock all of the funds. Instead, by using the laddering approach you can invest $2,000 each in CDs of terms 1-year, 2-years, 3, 4 and 5 years. This means every year you have $2,000 worth of investment maturing and becoming liquid again. You are then free to re-invest that amount in a 5-year CD and enjoy the higher yields of the longer-term instrument.

The laddering approach for a CD helps by

  1. making a portion of the portfolio liquid every year
  2. helping the investor gain from the higher yields of long-term deposits
  3. protecting the investor from increases in interest rates. For example, say all your money is tied up in a single 5-year CD at 1.8% APY, and you are in year 2. Now interest rates rise so that the going rate for a new 5-year CD is 2% APY. If you used the laddering approach, you will be able to invest a portion of the funds at the new rate when they mature from their previous CD.

References

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