CD vs. Savings Account: Which Should You Choose?

It boils down to flexibility and interest rates.

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James Martin/CNET

Sometimes the hardest part of saving money is deciding where to park it. Two good options — both of which are low-maintenance and low-risk — are certificates of deposit, or CDs, and savings accounts. Though they're both easy and inexpensive to open, there's a tradeoff between access and flexibility and interest rates. Here's how to choose between a CD and a savings account.

Savings accounts

A savings account provides a secure place to deposit money and earn interest. Interest rates have been quite low in recent years, though that's starting to change as the Fed has been driving them up in an effort to stem inflation — a trend that will eventually impact savings account interest rates. You can open a savings account at a traditional bank, credit union or online institution.

As you make deposits into your account, your interest rate (also referred to as a yield) is calculated based on a daily, monthly or annual basis. Each bank sets its own interest rate for its own financial products. 

Interest rates fluctuate based on market conditions. Many institutions currently offer high-yield savings accounts featuring interest rates at or above 2%, which is considerably higher than the rates that were available a few years ago.

Why you should choose a savings account

Savings accounts are one way to save your money with limited risk. A savings account might be a good fit for you if:

  • You don't want to risk losing money. While there's the potential to earn higher returns with an investing account, such as a mutual fund, savings accounts protect against loss. While any investment carries the potential of losing money, a savings account grows your money, slowly, with an annual percentage yield (APY). 
  • You can accept slower growth. Regular savings accounts at traditional banks earn very low rates of interest -- sometimes as low as 0.01% APY, though there are high-yield savings accounts which may provide up to 3%. The average return on stocks may be significantly higher, but there's always the risk of loss. 
  • You want easy access to your money. Savings accounts are highly liquid, which means you can withdraw or transfer funds with a few clicks or at an ATM. With an investment account, you may have to sell stocks or other securities to get cash, which can take days or weeks.

Certificates of deposit 

A certificate of deposit, or CD, is another type of savings account. Instead of making deposits at will, however, you make one lump-sum deposit and then leave the money alone for a set amount of time. This can range from six months to five years and possibly longer, depending on the account.

In most cases, the more you deposit and the longer your terms, the higher the interest rate you can earn. The interest rate won't change during that period, but you won't have convenient access to funds after the initial deposit; you can make an early withdrawal, but there may be a steep financial penalty. When you reach the maturity date, you'll receive your initial deposit plus any interest that's accrued.

Why you should choose a CD

A CD encourages long-term growth and mitigates the temptation to withdraw your money. A CD might be right for you if:

  • You won't need the money. CDs encourage you to "set it and forget it." You won't be able to easily withdraw your money until the maturity date. The longer the term, the longer you'll wait to get your money (and interest).
  • You want to lock in the interest rate. High-yield savings accounts offer variable interest rates, which can go up or down; CDs offer a fixed interest rate for a set amount of time. If you're worried about a looming drop, a CD can help protect your money before it comes.
  • You want to know exactly how much you're going to earn. With a fixed interest rate, you'll know exactly how much you'll earn at the end of your term — no guesswork involved.

How CD ladders work – and when you should use one

You can build a "CD ladder" by simultaneously opening multiple CDs with different maturity dates. When one CD reaches its maturity date, you take your initial deposit and the interest you've earned and open another one with a longer term and a higher interest rate. This is what it could look like:

  • $1,000 in a one-year CD with a 2% APY
  • $1,000 in a two-year CD with a 2.10% APY
  • $1,000 in a three-year CD with a 2.25% APY
  • $1,000 in a four-year CD with a 2.75% APY
  • $1,000 in a five-year CD with a 3% APY

After the first year, you'll take your original deposit plus any interest earned and open a new five-year CD with those funds. Next year, you'll do the same thing with the two-year CD. And on and on.

This is a particularly good strategy for savers who have enough cash to open multiple accounts. But if you don't have a sufficient amount to open a CD, you may be better off with a savings account.

CDs vs. Savings Accounts: Similarities and Differences

Availability

Both CDs and savings accounts are widely available at a variety of banks, credit unions and online institutions. 

Access

You can deposit into a savings account anytime you want and, in most cases, make up to six withdrawals or transfers per statement cycle. A CD limits your access. After you make your initial lump-sum payment, you can't withdraw it until the maturity date (and you can't add more to it, either). Depending on the particular term, your cash could be locked up for a few months or years.

Liquidity

You can take money out of a savings account, or move it to another account, easily and quickly. With a CD, you'll get penalized for touching it before the maturity date, making it far less liquid than a savings account. 

Interest rates

Savings accounts have variable interest rates that change according to market conditions. When the Fed raises rates, your savings account will eventually rise. When the Fed cuts rates, your savings rate will follow. 

A CD offers a fixed interest rate that will never change over the duration of your term. It's locked in.

Terms and minimum deposits

CDs tend to require a larger initial deposit to qualify for the highest rates. Most savings accounts don't have a minimum deposit but some do, and especially those that offer more competitive yields. 

Should you open a CD or savings account?

While both savings accounts and CDs are both good accounts for saving money, they have different features. Make sure to compare options to see which one is best for you.