While there are several different types of savings accounts, the three most common are the deposit account, the money market account, and the certificate of deposit. Each one starts with the same basic premise: give your money to the bank and in return the money will earn interest.
But each type of savings account benefits you in different ways. You may earn more interest from one than another. Others may allow you to access the money more easily, which is called liquidity. The savings account that’s right for you will depend on your specific situation.
Note that savings accounts are different from checking accounts, which have the most liquidity but typically earn no interest. Savings accounts are also not the same thing as investment accounts, which comprise not only cash but also stocks, bonds, and mutual funds, but don’t guarantee your money.
The first $250,000 in all savings accounts is backed by a government agency – the Federal Deposit Insurance Corporation (FDIC) for banks and the National Credit Union Association (NCUA) for credit unions.
Deposit savings accounts
Deposit savings accounts, also called transactional savings accounts, are the simplest way to store your money in a bank or credit union and receive interest for doing so. These types of savings accounts can be typically opened with a small minimum deposit, and you can avoid paying minimum deposit fees as long as you maintain it.
Transactional savings accounts also have high liquidity. You can easily transfer the money to a checking account or use it to preauthorized make bill payments. While you’re limited by federal regulations to making just six transactions a month, in-person and ATM withdrawals aren’t counted.
You can link a deposit savings account to the debit card associated with your checking account, although many savings accounts also come with an ATM card.
Because of this increased liquidity, transactional savings accounts usually clock in at the lowest interest rates, often expressed as the annual percentage yield, or APY.
You may be able to get higher interest rates by opening the account with an online bank instead of a brick-and-mortar one.
Money market accounts
Money market accounts are like deposit accounts in that you deposit money into them and the money gains interest. However, they could require a much larger initial deposit, and you could be charged fees if the balance dips below a minimum amount. The upside is that the best money market account interest rates may have slightly higher interest rates than other types of savings accounts.
Money market accounts have one important advantage over transactional savings accounts: they allow you to write checks against the balance. The six-transaction limit also applies to money market accounts, inclusive of check writing.
Because of the potentially higher interest rates and enhanced liquidity, money market accounts make great emergency funds if you can afford the initial deposit. Note that money market accounts are not the same thing as money market funds, which you buy into when you open an investment account, and, like all mutual funds, are not guaranteed by the FDIC or NCUA.
Certificates of deposit
Certificates of deposit (CDs) have the lowest liquidity but the highest interest rates. To save money in a CD, you purchase one for a maturation period, sometimes called a “duration” or “term.” The maturation period can last just a few months to 10 years, with longer terms yielding higher interest. The best CD interest rates hover between 1% and 1.35%.
You can withdraw from the CD before it is has matured, but you could incur hefty fees. If using the CD as an emergency or rainy-day fund, choose a shorter duration.
At the end of the duration, you don’t withdraw the money, then the bank or credit union holding the funds will reinvest them into a new CD for the same term. (You typically have a grace period before this happens, in case you forgot about the CD.)
Reinvesting the money into a new CD allows the interest to compound, so you earn money on the value of the original deposit plus the interest it earned over the maturation period.
CD Ladders
Some people “ladder” their certificates of deposit to maximize their earnings over shorter periods. While CD laddering can be costly to initiate, it works a little like this: Take $5,000 and invest it $1,000 into five separate CDs, each one with a term one year longer than the last, so you have $1,000 in a one-year CD, a two-year CD, and so on. Each time a CD reaches the end of its maturation period, it gets reinvested into a new five-year CD, so you earn more interest than you would if you’d get kept the money in a CD of the same term.
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As a financial expert with extensive knowledge in banking and savings strategies, I can attest to the critical importance of understanding the various types of savings accounts to optimize your financial portfolio. With a background in finance and a keen interest in personal wealth management, I've delved deep into the intricacies of deposit accounts, money market accounts, and certificates of deposit (CDs).
Let's break down the key concepts presented in the article:
1. Deposit Savings Accounts:
- These are fundamental, often referred to as transactional savings accounts.
- Opened with a small minimum deposit, avoiding fees with consistent maintenance.
- High liquidity, enabling easy transfers to checking accounts and preauthorized bill payments.
- Limited to six transactions per month due to federal regulations.
- Generally, lower interest rates, influenced by factors such as the annual percentage yield (APY).
- Liquidity advantage allows linking to debit or ATM cards, offering quick access to funds.
2. Money Market Accounts:
- Similar to deposit accounts, requiring a larger initial deposit and potential fees for falling below a minimum balance.
- Often boasts slightly higher interest rates than standard savings accounts.
- Allows check writing against the balance, enhancing liquidity.
- Subject to the same six-transaction limit as deposit accounts.
- Not to be confused with money market funds, which are part of investment accounts and lack FDIC or NCUA guarantees.
3. Certificates of Deposit (CDs):
- CDs offer the highest interest rates but with the trade-off of lower liquidity.
- Purchased for a specific maturation period or term, ranging from months to years.
- Longer terms yield higher interest rates.
- Withdrawal before maturity may incur substantial fees.
- CD laddering is a strategy to maximize earnings over shorter periods, involving multiple CDs with staggered maturation periods.
- Reinvesting the funds at the end of each term allows for compounding interest, potentially increasing overall returns.
Understanding these distinctions is crucial for making informed financial decisions based on individual needs and goals. It's important to note that while deposit accounts offer high liquidity, money market accounts strike a balance between liquidity and higher interest, and CDs provide the potential for significant interest gains at the cost of reduced accessibility. Always consider your specific financial situation when choosing the savings account that aligns with your objectives.
