CD vs. savings account: What's right for me?

Nobody should have to tell you how important saving for the future is. Times are tough all over — and government researchers say almost half of Americans don’t have a rainy day fund. You don’t want to be one of those statistics if you end up running into a financial speed bump down the road.

Fortunately, you have a few incredibly useful options to choose from when it comes to kick-starting your savings. For example, you may want to look at a Certificate of Deposit (CD), which is a savings product that helps you accumulate interest on a lump sum you deposit.

But it’s important to remember that a CD may not be right for every saver. This guide will explain what a CD is, how to set a CD up, and whether setting up a CD is better than opening a savings account or a high-yield savings account.

What is a Certificate of Deposit (CD)?

Before we talk about when it might make sense to set up a certificate of deposit (CD) versus a standard savings account, let’s take a look at how CDs actually work.

A CD is a savings tool that pays out interest for a fixed period on a lump sum of cash you’ve deposited in that account. Unlike a savings account, the money you place in a certificate of deposit must remain untouched for the entire term of your CD. Otherwise, you’ll be subject to withdrawal penalties or lost interest.

On the flip side, CDs normally have a higher annual percentage yield (APY) than you’d get with an ordinary savings account, which is essentially a reward for the loss in liquidity that you take on for opening a CD.

Most consumer banks and credit unions offer CDs. But each bank will offer different terms, rates, and early withdrawal penalties. These different terms and rates are normally carved out in relation to the rates on each bank or credit union’s traditional savings accounts or money market products.

When it comes to saving your money, CDs are normally considered a pretty safe and surefire way to build passive income for two reasons.

First and foremost, certificates of deposit benefit from a guaranteed fixed rate. That means there’s no risk that your return from a CD will be reduced or fluctuate. When you open a CD and deposit a lump sum of cash, you can calculate from the outset exactly how much money that lump sum will generate through interest by the end of your CD term.

The second reason CDs are considered a safe way to save cash is that they’re protected by federal insurance in the same way most savings products are protected.

This insurance is provided by the Federal Deposit Insurance Corp. (FDIC) for banks and the National Credit Union Administration (NCUA) for credit unions. It gives savers peace of mind by guaranteeing all deposits of up to $250,000 if your bank, credit union, or financial services provider were to go under while your money’s still deposited with them.

How do you set up a CD account?

If you want to set up a certificate of deposit (CD), you will have many options. Just about every bank or credit union offers a CD product — many of them offer multiple CD products with a wide range of various terms and rates.

But unlike a savings account, you can also set up CDs using a brokerage account. If you opt for this route, your CD is normally going to take the form of a bank certificate. Your broker is essentially just acting as a middleman between you and a bank or a credit union, but the CD’s certificate is held in your brokerage account.

In terms of the setup process, starting up a CD is fairly similar to setting up a standard bank deposit account. Whether you’re looking for a new savings account or a CD, you’ll want to shop around and ensure you have all the essential information about terms and rates before applying.

Once you’ve found the right CD for you, you’ll need to fill out an application form with your bank or credit union. This effectively locks you into a few things from the point at which you sign on the dotted line.

First, you’ll be getting locked into your bank — so you’ll want to make sure you’ve chosen wisely. Your bank or credit union will be the one that decides what early withdrawal penalties you might have to pay. Equally important, your bank will dictate whether your CD will get automatically reinvested if you fail to give them other instructions when the CD reaches the end of its term and matures.

Next, it’s important to understand that you’re getting locked into an interest rate from the moment you’ve set up your CD. Your CD’s interest rate will be locked for the duration of your CD term. That gives you a clear and totally predictable return on investment (ROI) for a certain period of time. Armed with this information, you’re going to be able to project how your savings will grow over time — which is a big help when planning for the future.

You’re also getting locked into a specific term when you open a CD.

Your term is the precise length of the CD agreement you’re setting up with your bank or credit union, which is essentially just the amount of time you’re agreeing to keep your money deposited in the bank. Your typical CD term is going to run for six months, 12 months, or 18 months — but some banks will offer CDs that run for longer periods.

When your CD term comes to an end, it means you’re allowed to withdraw your cash from the account without penalty. In some cases, your CD might automatically transfer to an ordinary savings account or get renewed under new terms. That’s why asking questions and understanding what you’re getting locked into before you agree to deposit your cash is critical.

Finally, there’s your principal amount to consider. Many banks and credit unions have a minimum deposit requirement for CD products. You should be aware of this requirement before setting up a CD with your bank, as this could become a headache if you don’t have enough cash to meet your bank’s principal deposit requirement.

After you’ve set up your certificate of deposit, your bank or credit union will administer it just like they would any ordinary savings deposit account. They should provide regular statements, interest payments, and communications about your account throughout your CD term.

Is it better to put your money in a CD or a savings account?

While a typical certificate of deposit (CD) and savings account have quite a few traits in common, there are some fundamental differences between them. That’s why it’ll make more sense in certain situations to set up a CD — while others might be better suited for opening a standard savings account.

To help give you an idea, let’s quickly break down when you should consider opening a CD instead of a savings account.

When is a CD better than a savings account?

A CD is a low-risk savings option that helps you generate passive income through APY interest. Because CDs have a fixed interest rate, you’ll know exactly how much interest you’ll accumulate over a certain period — whether it’s three months or two years.

Bearing that in mind, CDs are a great tool to meet your medium-term savings goals.

For example, let’s say you want to get on the housing ladder and purchase your first home in three years. As a way to build your cash pool to make the initial deposit alongside your mortgage, you could choose to deposit a lump sum in a CD. That sum would then sit protected in your CD and grow in size until it matured — at which point you could put the cash down on your new home.

CDs generally have better interest rates than ordinary savings accounts, but the price of that higher interest is that you won’t be able to access your funds until the CD matures. That means a CD is ideal for those who want to generate income through interest payments but don’t need immediate access to their money.

When is a savings account better than a CD?

A savings account is usually a smarter option if you think you’ll need regular access to your cash in the near future.

That’s because you can’t withdraw funds whenever you need to with a CD (without paying a penalty fee). But with a savings account, you’re allowed more flexibility for regular withdrawals.

This immediate access to cash makes a savings account ideal for creating an emergency fund. Savings accounts are also great for short-term savings goals — like saving up for a big vacation overseas. You’ll be able to generate interest on your savings so that it’s still growing over time. But if plans change or an emergency strikes, you’ll benefit from the ability to withdraw what you need when you need it.

Is it better to set up a high-yield cash account?

We’ve covered how certificates of deposit (CD) and savings accounts work. But it’s important to understand there are other savings products that can help you generate passive income through interest payments.

One option to consider is a high-yield cash account.

A high-yield cash account is a savings product that offers savers bigger interest rates than traditional savings accounts. In fact, the right high-yield cash account can generate a higher APY for savers than CDs can.

Like a CD, a high-yield cash account offers compound interest. That helps you earn more interest faster because you earn interest on the interest payments you’ve already received in your account.

Meanwhile, you can also withdraw the cash in your high-yield cash account or transfer it up to six times per month without worrying about paying any fees if an emergency pops up.

As a result, high-yield cash accounts give you the best of both worlds; you get the higher interest rate of a certificate of deposit with the accessibility of a “normal” savings account.

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Conclusion

If you’re looking for a way to generate savings for the future at an above-average interest rate, a CD might be worth checking out.

Setting up a CD is easy, and the process is similar to setting up a savings account. You just have to shop around to make sure the terms are going to match your savings goals.

In some situations, a CD is going to be a smart option. But in other cases, it might make more sense to set up a traditional savings account or a high-yield cash account.

A high-yield cash account like Boost can offer the best of both worlds: the high interest rates of a CD alongside the flexibility of a savings account.

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