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2015 Perspective: Should I Choose a CD or a High-Yield Savings Account?

Banking, CDs, Savings Accounts
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The Federal Reserve intends to keep the federal funds rate low through 2015 in efforts to spur economic growth. For consumers, this means lower rates for mortgages and loans (good), but also low rates on savings (not so good). In this low interest rate environment, savers are struggling to find a competitive yield on their deposits. In most cases, the rates that banks and credit unions are offering in exchange for depositing money at their institution are hardly keeping up with the rate of inflation (losing money in real terms).

The facts

NerdWallet’s weekly analysis of CD rates revealed the following rate offerings for CDs:

  • Certificates with terms of less than 24 months are averaging below 0.50% APY
  • Only those accounts with terms of greater than 4 years averaged over 1.00%

Most savings accounts, by comparison, are not able to maintain these same yields. The biggest banks offer rates of 0.05% or less. For this reason, many consumers have been turning to online banks for higher savings rates. Here’s an example of a few high-yield savings accounts that anyone can easily open online.

The risks

Interest rate risk is part of the equation on both sides of this question. A high-yield savings account is not guaranteed to maintain that same rate forever. The bank may choose to raise or lower the rate depending on the current environment.

CDs allow you to lock-in a rate for the term length, which is great if rates continue to decline. The flip side, of course, is that rates may rise in the coming months and years. In that case, you’ll be stuck earning a lower rate than you could otherwise get. Early withdrawal penalties would restrict moving cash to a different account before the term is up.

NerdWallet’s recommendations

If you’re deciding between a short-term CD (less than four years) and a savings account, choose a savings account.  Since short-term CDs cannot compete with the high yields of an online savings account, the primary concern is whether the lack of access to your money is worth the additional interest earnings.

Consider a consumer with $20,000 in deposits (the median value of CD holdings for those families holding deposits in such accounts). We assume the highest available online savings rate and the average 5-year CD rate, 1.26%.

If you have a large amount to invest, and are absolutely certain that you will not need to access the excess cash for a long period of time, then a longer-term CD may be the way to go. Otherwise, the savings account is probably better for its ease of access and rate flexibility. $376 is a relatively affordable price to pay for peace of mind over 5 years. Your savings account balance will be available penalty-free in case of an emergency, and since rates are unlikely to fall much further, your interest rate might just increase over time instead of being locked into a low CD rate.

NerdWallet can help you find the best cd rates and high-yield savings accounts in your area from thousands of credit unions, online banks, and traditional banking institutions.

Other expert opinions

First, individuals should visit the U.S. Treasury website before researching what yields are being offered by banks to see how the 2 to 10 year treasury curves have performed over the past 12 months. Historically, yields will receive a bump between January and March (for example, in 2012 and 2011, yields rose more than they declined on a daily basis), so these periods will likely be the best time to invest in CDs in today’s low interest rate environment. Outside of finding the best rate, search for accommodating features from a bank as well:

–     Possibility of having your interest rate increased if they do go up once you’ve purchased

–     Ask if   you can have the withdraw penalty waived if you invest a certain sum of cash for a certain period of time (leverage your investment with banking products)

If all else fails in your search for a reasonable rate on a CD, then electing a high yield savings account is the way to go. If you find a high yield savings account that seems too good to be true, call the bank to see about all the details of the account to see if you’ll qualify. If the details make sense, then ask the rep how this account’s rate has changed over the last several months, you want to make sure the rate isn’t bouncing up and down month to month which would dilute the possible interest you expect to earn while saving with the account.

With many people feeling like the economy is still on shaky ground, a Certificate of Deposit or CD is just too risky for many Americans due to the lockup period and costs and hassle of accessing the money in an emergency (medical, loss of job, home repair. etc).

Let’s compare some rates; the nation’s leading rate on a 5 year CD is 1.75% from Discover Bank, with a minimum $2,500 deposit. ING Direct offers a rate of 0.80% for their online savings product. While a difference of 0.95% annually is not insignificant, consider what that would earn you over a year. On a $100,000 deposit that’s still only $950 more per year from the CD. Is that enough to risk a 5 year lockup? If the extra money tempts you, consider instead locking up a portion in the CD for higher yield and keeping enough for an emergency in a savings instrument. 

Savings growth image via shutterstock