Beyond Today's Interest Rates: Comparing Certificates of Deposit and Savings Accounts
May 18, 2009
Under normal circumstances, the choice between certificates of deposit (CDs) and savings accounts is a trade-off between yield and liquidity. CD rates tend to be higher than savings account interest rates because CDs lock up your money for a longer time. So what do you do when, as was the case recently, some banks are offering savings account rates higher than even 2-year CD rates? Does this automatically make the savings account the best of both world --yield and liquidity-- or is there more to it than that?
There are a couple of additional considerations you should take into account before you assume that a higher-yielding savings account is the equivalent of tastes-great/less-filling in this scenario.
Fixed vs. Variable Interest Rates
As mentioned above, there is generally a trade-off between liquidity and interest rates. The premise is that you give up liquidity to gain more in interest rates. However, what if you don't need immediate liquidity? Then, the dynamic changes.
If liquidity isn't an issue, then locking up an interest rate can actually be an advantage. If you see an interest rate you like, you can capture it not just for today, but for the term of the CD.
In contrast, savings account interest rates are highly variable. The rate you choose is really just a one-day snapshot, and the picture can change radically over the next year or two.
Interest Rate Expectations
Of course, that change might be for the better rather than for the worse, so a key factor in choosing between fixed and variable interest rates is your perspective on where rates are going. If you see them falling, fixed rates are the way to go. If you see them rising, the advantage is with variable rates.
All-in-all, this shows the benefit of being an active shopper for bank products. Anomalies do occur, and when this happens it can create opportunity.
