Certificates of Deposit vs. Money Markets

Whether a Certificate of Deposit or Money Market Is Better for You

Customer depositing cash at bank
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For people who want to generate some interest income from their cash savings, two popular choices are money markets and certificates of deposit (CDs). Both of these savings vehicles achieve the same goal of earning a relatively secure stream of passive income, but they have unique advantages and disadvantages that are important to understand—including differences in terms, yields, pricing, conditions, and restrictions.

Deciding between the two will come down to your personal circumstances, resources, and portfolio preferences. The first step in making this decision for yourself is to learn exactly what each savings vehicle is, and how they differ.

Here's an overview of how CDs compare to money markets.

Certificates of Deposit Overview

A CD is a special type of debt instrument issued by banks and other qualified financial institutions to individuals who want to invest their savings and earn interest income. When you buy a certificate of deposit, you are essentially lending money to a bank. The bank takes the money for a pre-determined length of time. When that time is up, the CD has "matured," and the CD holder will receive a payment from the bank.

As long as the CD-issuer is FDIC-insured, the bank's promise to return the money is covered up to the $250,000 FDIC limit, just like funds in your savings or checking account. Even if the bank collapses, the owner of the CD will still get their money returned.

Common timelines for CDs range from roughly three months to several years. Depending on the institution issuing the CD, you may receive higher interest rates for picking a CD with a longer timeline. CDs also differ in the way they distribute interest income—it may be monthly, quarterly, annually, or all at once upon the CD's maturity.

The size of your deposit may also impact the CD's rates. CDs worth $100,000 or more are often called "jumbo CDs," and they typically offer higher interest rates. In some cases, you can use a CD to create a secure line of credit, with the bank holding the CD as a form of collateral. This can give yourself increased access to potential liquidity as you earn interest income.

Some people buy CDs directly from their bank. Many larger brokerage firms also allow customers to buy CDs in their brokerage and retirement accounts, such a Roth IRA or Rollover IRA. CDs bought through a brokerage firm are known as "brokered CDs." A customer could hold a variety of brokered CDs from different institutions within a single account.

Why Banks Issue Certificates of Deposit

When you buy a CD, the bank turns around and distributes those funds as loans to borrowers. The bank charges higher interest rates than your CD, so it can repay the CD (plus interest) and still have some profit left over to pocket for itself.

This allows the banks to take on the risk of lending, keeping your money safe. You don't have to worry about monitoring the credit risk of potential borrowers. The owners of the bank do take on risk, and they generate a profit for it, which allows them to pay employees, open new branches, and distribute cash to stockholders as a dividend.

What If You Can't Wait for the CD to Mature?

If you need access to the money tied up in your CD earlier than the maturity date, you will likely have options, but it depends on the type of CD you own and who you acquired it from. Most traditional banks will redeem a CD for you before the maturity date in exchange for an interest rate penalty. For example, you may have to give up six months' worth of interest income.

On the other hand, if you acquired the CD through a brokerage, it may be treated more like a bond. You can try to sell the CD to another trader, but you'll have to wait for someone to make a bid on it, and you may not receive a bid for the entire value of the CD.

Money Markets Overview

There are two different types of money market investments: accounts and funds. These may appear and function similarly, but they are different in their structure and risk.

Money market accounts are special FDIC-insured savings products offered by banks. They tend to pay higher interest rates than regular savings accounts, but they may have stricter limits on withdrawals, such as a limit on the number of checks that can be written against the account during a six-month period. Failure to adhere to these withdrawal limits could result in penalty fees.

Money market funds, also known as money market mutual funds, are not insured by the FDIC. These money market products are actually mutual funds that hold investments such as Treasury bills and CDs. Money market funds are designed to maintain a value of $1 per share at all times, but when they fail to do so, it is known as "breaking the buck" and can cause a run on the fund.

If you are investing through a 401(k) plan, you might encounter something known as a stable value fund, which looks and acts like a money market fund, but the returns are backed by a contract with an insurance company.

Comparing Certificates of Deposit and Money Markets

CDs and money markets are different products with different advantages.

Certificates of Deposit Allow for Accurate Planning

CDs come with specific terms that are FDIC-insured. Before you buy a CD, you can calculate your expected earnings before investing because you know your interest rate and tax bracket. This isn't possible with money market accounts or money market funds because those interest rates fluctuate over time.

Also, a money market account's interest rate might vary by balance, which means it could change as you deposit more or withdraw funds. This makes CDs an ideal solution for individuals who want to focus more on capital preservation than growth.

Money Markets Offer Flexibility

Although CDs typically have higher interest rates than money markets, your money is locked up for several months or years. Opting for a longer maturity involves a certain degree of opportunity cost risk; the longer you lock away your money, the more likely it is that better opportunities for your money will arise.

Money markets are very liquid, and you can withdraw your funds at any time with no penalties (as long as you aren't frequently making withdrawals). Unless there is a liquidity crisis or fund-specific catastrophe, the odds are good that your money markets are going to be available to you with much less hassle than a CD.

Also, while the fluctuating interest rates of money markets could be a negative for many investors, it may not be a negative for all investors. High-income investors or investors with significant amounts of capital may prefer money market accounts since the interest rates usually increase as the balance grows.

The Bottom Line

Both CDs and money markets are useful for those who want to earn passive income without diving into securities like tax-free municipal bonds or corporate bonds. For those who need easier access to their money, a money market may be a better option. For those who don't mind locking away their savings for an extended period, CDs are often the better portfolio selection. As with any financial issue, talk with an investment advisor or another qualified professional to discuss what makes sense for your personal situation.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Article Sources

  1. Federal Deposit Insurance Corporation. "Insured or Not Insured?" Accessed June 8, 2020.

  2. Office of Investor Education and Advocacy. "Certificates of Deposit (CDs)." Accessed June 8, 2020.

  3. Consumer Financial Protection Bureau. "What Is a Money Market Account?" Accessed June 8, 2020.