You have probably heard that CDs are a safe investment instrument but, if you are like most people, you really don’t quite understand the difference between CDs vs. savings accounts. They are similar in that both require you to deposit money with a bank or other financial institution, but there are vast differences as well.
Once you understand the difference between a savings account and a CD account, you will be in a better position to know which is best for you.
How a CD Works
A CD (Certificate of Deposit) is actually nothing more than a loan you make to a bank or financial institution of some kind. In return, they give you a paper called a Certificate of Deposit, which we most commonly simply referred to as a CD.
A CD, then, is a loan you make to a bank and in return, they agree to pay you a predetermined rate of interest if you leave your money in the bank for the agreed-upon term (length of time).
It is suggested that you only invest the amount you can afford to go without for this period of time because you will pay a penalty for early withdrawal. Also, bear in mind that CD rates will vary from bank to bank, just like savings account interest varies from bank to bank, so you will want to do a bit of comparing if you are going to invest in a CD.
Main Differences between a CD and a Savings Accounts
If you look again at how a CD works, you will see there are two main differences, which are obvious from the very beginning. The first is in regards to how long you need to leave your money in an account and the second is the interest rates attached to both.
CD vs. Savings Account – Terms and Penalties
The most important difference between a CD and a savings account is the length of time you are required to leave your money in a bank. When you open a standard savings account, you can withdraw any or all of your money at any time you desire without being charged a penalty. The money is yours to use as and when you like. However, if you need to take your money out of a CD before the agreed-upon term, you will be assessed a penalty, which will defeat the purpose of higher returns on your deposit.
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CD vs. Savings Account – Rates
Both a CD and a savings account will accrue interest, but the rates of interest may vary significantly. Rates vary from bank to bank, but with a CD you have to leave your money in the account so you will accrue what is called compound interest. Your money grows to a greater degree because you earn interest on interest over time.
So Which Is Best for You?
In the end, only you know how much money you can put aside without touching for an extended length of time. In a CD, you must leave your money in the account until it reaches maturity (that predetermined length of time) or you will be assessed a penalty, also predetermined in the CD. If you feel you cannot set that money aside without touching it, a savings account may be the better choice. Again, only you know your finances, so choose wisely.