If you have some excess funds and want to get the best return, you have a number of options. If you don’t want the riskiness of investing in the stock market, your two main options are a high interest savings account or a CD. But, which one is best? Understanding them both is important to help you answer this question.
The High Interest Saving Account Basics
As the name suggests, high interest savings accounts are like a standard savings account, but you can receive a higher APY on your balance. While high interest savings accounts are typically offered by online financial institutions, there are some traditional bricks and mortar banks that also have this type of account available.
The main advantage of these bank accounts is that you can typically access your funds with no penalties. However, many accounts restrict the number of times you can withdraw funds in a calendar month. If you do withdraw money, either through bank transfer, ATM withdrawal or other methods, more frequently, you risk account closure.
For this reason, many financial institutions don’t offer an ATM card with the account. If you want cash from your account, you need to arrange a transfer to another one of your bank accounts. You can then draw out the cash using an ATM or teller counter at your local branch.
However, you can add funds to your high interest savings account as and when you like. You can simply transfer funds into the account or set up a regular payment order to continue building your savings every month.
The CD Basics
CDs or certificates of deposit are a different type of savings product. Each certificate has a set term, which can vary from as little as one month to five years or longer. Once you open the account, you will fund it and lock in the interest rate for the duration of the term. After this point, you will not be able to add more funds to your account. Additionally, unless you choose a no penalty CD, your funds are locked into the account. If you need to make a withdrawal before the maturity date, you’ll be subject to an early repayment penalty. This could be a set amount or a percentage, and it can also vary according to the original CD term. Generally, longer term CDs have a higher early withdrawal penalty.
When the CD reaches its maturity date, you can withdraw the funds or roll them over into a new CD. You can choose a CD with a similar term, or move the money into another bank account altogether.
CDs are available from both traditional banks and online financial institutions, but the rates can vary widely. It is possible to shop around for the highest rates, but bear in mind that higher rates are typically reserved for longer term CDs.
The advantage of this is that you can guarantee the return on your savings amount, provided that you don’t make any withdrawals before the maturity date. Effectively, you’re locking in the rate when you open your CD, so if there is a downward interest rate trend, it won’t impact you. On the other hand, if the market rates increase during the CD term, you won’t be able to access a higher rate.
There are some exceptions to the above scenario, Some financial institutions offer a “bump up” CD, that allows you the opportunity to “bump up” your rate to the current market rate once during the term of your CD. Of course, you will need to have innate timing to get the best deal, but this is a good option if you want to put your money in a CD at a time when rates are uncertain.
The Strategy of CD Laddering
One of the main drawbacks of CDs is that your money is tied up for the CD term. If you need to make a withdrawal before the CD matures, the penalty could add up to more than the interest you’ve already earned, which would wipe out any gains.
This can be a problem, if you are unsure whether you may need access to the funds. However, you can negate this with the strategy of CD laddering.
CD laddering involves having multiple CDs simultaneously, each with a different maturity date. If implemented correctly, you could have a CD maturing each month and you can then decide if you need the funds or can reinvest them into a new CD.
Setting up a CD ladder can seem a little complicated, but once you get into the swing of it, it is quite easy to manage. For the purposes of this example, let’s assume that you have $12,000.
On day one, you would take $4,000 of your fund and open four new CDs: a one year, nine month, six month and three month. Put $1,000 in each of these CDs. Repeat this after one month and again in the third month.
After three months, your first CD will mature, you should reinvest those funds into a new one year CD. Each subsequent month, when a CD matures, you will repeat this process. Once the last of your nine month CDs has matured, you’ll have 12, one year CDs established. This means that you will have a CD maturing every month, and since the CDs have a medium term, you should be able to access higher interest rates.
CDs vs High Yield Savings Accounts
Both of these types of bank accounts are designed to offer savers access to higher than average rates, but there are some key differences that will impact which is best for your savings needs.
Accessibility
High yield savings accounts are more accessible compared to CDs, as in theory you can make a withdrawal when you like. However, your account may have a maximum number of withdrawals you can make each calendar month. Generally, there are no limits on the amounts you can withdraw, so, you can access your funds and pay any remainder back into the account if you find you no longer need it. Some financial institutions provide an ATM card associated with the high yield savings account, otherwise, you will need to arrange a transfer to another of your bank accounts.
CDs have a set term, making them harder to access. If you need to withdraw any or all of the money before maturation, you will incur an early withdrawal penalty. As we touched on earlier, some financial institutions offer no penalty CDs, which allow withdrawals with no penalties, but these typically have a lower APY compared to similar term standard CDs.
Account Requirements
Some financial institutions impose minimum balance requirements to open and maintain a CD or high yield savings account. Bear in mind that CDs do not allow additional funding, so the minimum balance will also determine the initial deposit amount.
It is important to check the account requirements for specific financial institutions to ensure that you are comfortable before opening an account. Remember that not all financial institutions impose these requirements. There are many online and traditional banks that allow you to open a high interest savings account with just $1 or you can open a CD with any amount.
Fixed vs Variable Interest Rates
Most high yield savings accounts offer a variable rate. This means that if there are any changes in the base rate, it will impact the amount you receive on your savings balance. So, if the base rate increases, you may get a higher APY, but if the base rate drops, you’ll earn less on your balance. This introduces a little risk into what is otherwise a low risk savings product.
CDs allow savers to lock in a fixed rate for the duration of the CD term. There are some exceptions, but typically, you can know in advance the return you can expect on your savings amount. This provides greater stability, but as we discussed above, it can be a disadvantage if the base rate increases significantly during your CD term.
The Potential For Ongoing Savings
This is a key difference that may ultimately determine which type of account is best for you. High yield savings accounts work like basic savings accounts, and you can move money into the account as required. On the other hand, CDs only permit an initial deposit, so you cannot add extra funds later. This is not a massive drawback, as you can simply open another CD, but the second CD may not have the same terms or rate. Additionally, if there is a minimum initial deposit amount, your extra funds may not be sufficient to open another CD.
Which Bank Account is Best?
There is no simple answer to this question, as it will entirely depend on your specific requirements, preferences and financial circumstances.
High yield savings accounts tend to be the better option if you want to save on a regular basis. You can add money to your savings account with each paycheck; you can even set up an auto transfer to set and forget it. If you’re saving for a specific purpose in the short term, such as a vacation, this type of account will allow you to withdraw funds if you need to pay for flights or other expenses before your actual vacation date.
If you don’t have any immediate or short term plans for your money, a CD can be a good way to lock in a preferential rate. You can compare the rate differences for the different terms and determine which one is best for you. You will then know exactly how much you will earn on your savings amount and when you’ll be able to access your funds.
To decide if a CD would work better for you or if you should open a high yield savings account, you will need to think about whether there is a possibility that you will need access to the money in the short to medium term. If there is a chance that you may need the funds, you will either need to consider a high yield savings account or a CD with a very short term.
For example, if you’re looking for an account to hold your emergency fund, there could be a chance that you will need immediate access to some or all of your funds. In this scenario, you won’t want to wait for a CD to mature to pay for a vehicle repair or other unexpected bill. However, if you’re putting money away for a home deposit in a few years, you may want to avoid the temptation of touching your savings. In this case, locking them away in CDs periodically will help you to accumulate the best possible returns.
Tips for Choosing the Right Bank Accounts for You
There are numerous financial institutions that offer high yield savings accounts, and CDs, so it can seem a little daunting to find the right account for you. Fortunately, there are some tips that can help you.
Assess Your Timeframe
This follows on from what we covered above, but think about your timeframe or savings purpose. This will help you to narrow down your savings product choices. You may find that you are willing to have a little less flexibility if you can access a higher APY.
Compare Like for Like
The first thing you’ll need to do is make sure that you’re comparing like for like products. If two financial institutions offer CDs, compare the rates for the same term products. Most financial institutions have tiered APYs for CDs according to the term length. Generally, longer term CDs have a higher rate, but there are some exceptions.
When shopping around, look at the rates for the different terms and compare them with the other bank’s CDs with the same terms.
Check Minimum Deposit Requirements
Some banks have a minimum amount that you need to open and maintain your account. Obviously, if you don’t have this amount of money to save, these bank accounts will not be available to you.
You don’t want to end up with an interest penalty or other fee that negates the returns on your savings fund.
Verify Fees and Charges
Although many financial institutions are eliminating monthly maintenance fees, some banks do still impose them. So, it is important to read through the account terms and conditions before you open any new bank accounts.
Every financial product is accompanied with a page or two of fine print and it can be tempting to simply skip reading this potentially boring and technical document. However, the terms and conditions will detail any fees or charges that will apply to your account. This includes if there are any fees for transfers, any maintenance fees, or any minimum balance requirements.
Some accounts will automatically convert a high yield savings account into a standard account if the balance drops below a specified amount. This means that you could immediately miss out on a much better rate, just because of a dollar or two.
Check Your Bank’s Offerings
Before you start scouring the internet or reading lots of mailers, be sure to check what products you can access with your existing bank. The bank you currently use for your checking account may offer some great deals for customers wanting to open a new account. You may even find that you get preferential terms or discounts on account maintenance fees when you open a savings account alongside your checking account.
Consider Online Banks
Typically, online banks offer the highest returns on savings accounts. As they have no physical branches to support, the costs of operating the bank are lower and these savings tend to be passed on to the customer.
For this reason, online banks can offer CD and high yield savings rates that are many times the typical savings rate provided at traditional banks. There are exceptions, but don’t overlook the potential of online banks.
Just be sure to check that the online bank is properly registered to provide FDIC insurance coverage. This federal protection provides account holders coverage for up to $250,000 in the event that the financial institution fails.
Why Not Try Both?
Provided that there are no minimum balance requirements or fees to cover, if you’re still struggling to decide whether you would be better with a high yield savings account or CD, why not try both. You can regularly save into your high yield savings account and periodically move the money into a CD offering a better rate.
If the market rates start to fall and you can’t get a higher APY with a CD, you can simply leave the money in your high yield savings account.
Choosing new bank accounts can be a little overwhelming, but if you want to get the best return on your savings funds, it is important to take a little time to assess your options. Whether you’re leaning more towards CDs, prefer a high yield savings account or are considering both, make sure that you choose a reputable bank with minimal fees and reasonable terms to make the most of your money.
