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Checking account, savings account, CD, or money market account?

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It’s all a trade-off between flexibility and yield
You probably already have a checking account. It is the most flexible type of deposit account, with few limitations on accessing your money. However, checking accounts also tend to have the lowest rates out there, hovering around 0% at most big banks these days.

Want to earn more? Promise the bank you won’t touch your money.
Willing to give up a little flexibility to earn more? Let’s talk savings accounts and money market accounts.

The most important factor in determining whether you should step up from a checking account to one of these higher yielding accounts is a Federal law that says you cannot access money from a Savings account or Money Market account, more than 6 times per month, using checks, ATMs, or ACH transfers.

In fact, according to the Federal Reserve, the bank will be forced to shut down your account if you are a repeat offender. This is unfortunate because savings accounts and money markets tend to pay higher interest rates than checking accounts.

If you’re OK with even less flexibility, consider a CD. CDs typically last anywhere from 6 months to 5 years; the longer the CD, the higher your interest. CDs also tend to pay even higher interest rates than Savings accounts and Money market accounts.

CDs vs Savings Accounts vs Money Markets – The basics.

  • Savings accounts and Money Markets are “Middle of the Road” – they offer better rates than a checking account, but lower rates than a CD. If you are absolutely sure you won’t need the money for 6 months or more, you should probably get a high yield CD instead. However, if you might need to access the money every now and then (<6 times a month), these are the best choice.
  • CDs usually have early withdrawal penalties, so don’t put your money into one unless you are sure you won’t need it for the duration of the CD. CD Durations/Terms range from less than 6 months to more than 5 years.
  • Tax exempt bonds may be a good option if you’re lucky enough to pay an extremely high marginal tax rate. Municipal bonds funds are exempt from local and Federal taxes, while US treasuries are exempt from local taxes. Traditionally, these instruments often have better after-tax yields than CDs. However, for reasons beyond the scope of this post, the current financial crisis is causing these yields to be extremely unfavorable at this time.

Aren’t living paycheck to paycheck? Split up your money.
If you are lucky enough not to be living from paycheck to paycheck, the best solution is to split off some of your assets into a checking account, and dump what you don’t need into the highest yielding account type that suits your needs.

At the time of this writing, that happens to be a long term CD. However, rates change all the time, and there may be times when Savings Accounts, Government Bonds, or Municipal Bond Mutual Funds might better fit your needs.

Not sure if you’ll need the money? Try rolling CDs.
There are many strategies to maximize your yield, even if you are unsure about whether or not you’ll need access to all or some of your deposits.

Longer CD deposit time frames usually mean higher rates, but if you are unsure whether or not you’ll need the money, you may want to consider rolling CDs.

One popular strategy is to buy a ladder of CDs: put 1/3 of your money in 1 year CDs, 1/3 in 2 year CDs, and 1/3 in 3 year CDs. When your 1 and 2 year CDs mature, reinvest them in 3 year CDs. This way, after the first two years, you will always be earning a 3 year CD yield, and you will always have a CD maturing each year.

Be careful – you usually have a 7 to 10 day grace period to remove your money from an auto-renewing CD, otherwise you’ll be penalized for removing money that has been rolled into a new CD.

Unhappy with current rates? You probably shouldn’t opt for “Bump” CDs and No Penalty CDs
There are many exotic CD types targeted towards people who are unsure whether or not they will need the money (no penalty withdrawal CDs), and also towards people who think rates might change (bump CDs that give you a one time chance to re-adjust the interest rates for example).

The problem with these CDs is that they pay out lower rates than normal CDs, in exchange for this optionality. In terms of penalty-free CDs, keep in mind that normal CDs usually only penalize you a few months’ interest for early withdrawals. Big banks are a HUGE exception to this rule. If you withdraw money more than 1 year before your CD maturation at Chase or Bank of America, you are penalized $25 + 3%. At Capital One, they use some fancy math to come up with an “economic replacement value” that can total thousands of dollars depending on how much rates have moved.

Some aren’t so bad. PNC charges 6 months’ interest for example, if you pull out money more than 1 year early.

Do the math. The banks certainly have, and they are betting that these fancy products will make them more money than traditional CDs – otherwise they wouldn’t be offering them!

As a rule of thumb, we think you’re better off going with higher yielding traditional CDs instead of trying to figure out where interest rates are headed.

And we also think you’re better off figuring out what your early withdrawal penalty is, in dollar terms, before jumping into a “No Penalty” CD at a lower rate.

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  • Pingback: NerdWallet Interest Rate Monitor: Deposit Accounts that Beat Inflation – February 2013

  • padden

    You’re better off investing in bitcoins ! CD’s offer single digit returns. Bitcoin has yielded triple digit returns.

  • http://www.facebook.com/thermbeffect rmbeffect

    index funds or ETFs may be a better solution

  • Robert Perlberg

    I have a savings account at a certain bank but no checking account. The bank called and told me I would get a higher rate on my savings account if I opened a checking account, even if I didn’t use it. Why is this? I’m skeptical as to whether I should do this. If the bank is so hot for me to do this, I figure there must be some “scam” aspect to it that I should be wary of.

    • NWjohn

      Banks often use incentives like higher interest rates to get customers to cross-sell new accounts and services (like a checking account, in your case). Theoretically, the more accounts you have with a bank, the more profitable you are as a customer and the harder it is for you to switch.

      If you choose to open the checking account to earn the higher rate of interest, keep in mind that you could be on the line for monthly fees or other charges, even if you don’t use the checking account at all.

      • Robert Perlberg

        Thank you.