When it comes to money that you may have to tap soon, it's usually best placed in a conservative type of investment. For example, your emergency funds should be in an account that won't drop in value when you need to cash it in. This can also apply retirement savings as your prepare to leave the workforce, or to college savings accounts as your child approaches high school graduation.
Because of their low-risk nature, cash accounts such as money market accounts and CDs can offer help protect your savings in situations like these. But it's important to understand how these types of deposit accounts work before you decide which is right for you.
What are certificates of deposit (CDs)?
A certificate of deposit (CD) is a contract with a financial institution, paying a contractual rate of interest, that you buy for a specific term raging from three months to several years. Here are some of their key features:
- CDs always require a minimum time commitment. It's important to consider your present and anticipated financial needs when deciding how long to invest in a CD. Some investors choose to buy multiple CDs with terms of varying lengths, which maximizes liquidity. This strategy is called "laddering."
- CDs come in many varieties. You may encounter fixed-rate CDs, variable-rate CDs, or even CDs that protect heirs from paying early withdrawal penalties. Read the fine print for any CD you're considering. It's essential to know all of the terms applicable to your CD.
- FDIC-insured CDs offer strong security. Unlike stocks and mutual funds, the FDIC protects the CDs it insures up to a maximum of $250,000 per depositor per institution.
- Early withdrawal penalties may apply. Make sure you understand the amounts and terms for penalties assessed before investing.
- Your yield will vary with your commitment. In general, the more you invest, and the longer you invest it, the better the return.
If you're not able to tie up large sums of money for long periods of time, a money market account can help you save while offering more liquidity. When considering which is right for you, shop around -- sometimes institutions that want to attract new customers will offer exceptional rates on money market accounts that may allow you to get a better return without tying up your funds.
What are money market accounts (MMAs)?
If you're not able to tie up large sums of money for long periods of time, a money market account can help you save while offering more liquidity. Money market accounts typically bear strong similarities to interest-bearing checking accounts and savings accounts. Here are some of their common components:
- They are also secure. Like CDs, money market accounts from FDIC-insured institutions bear very little risk for deposits up to $250,000.
- They may offer attractive yields. MMAs generally pay higher interest rates than regular checking or savings accounts, combining the advantages of easy access with a rate of return comparable to some investment products.
- Your rates will vary with the market. Money market account interest rates tend to follow short-term market interest rates.
- They usually have minimum opening deposits and balances. You may have to come up with a fairly large deposit to open an MMA. You may also have to maintain a minimum balance to avoid a monthly fee.
- They are different from money market funds. Don't confuse money market accounts with money market mutual funds, which are not FDIC-insured. Money market mutual funds are investment products and may carry some of the risks associated with investing in the stock market.
Whatever your choice in asset-preservation investments, it's important to check rates and terms on both CDs and MMAs. While it is generally true that tying your money up longer gets you a higher interest rate, that's not always the case. So shop a bit to ensure that you are safely maximizing both your liquidity and your rate of return.