Money Market vs. CD: What Makes More Sense For You?

Understanding the Nuances

Money Market Mutual Fund
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Liquidity is a staple of any financial plan. Liquid assets like cash are often set aside for short-term spending needs and emergency funds. However, you also don’t want your cash to just be sitting around idle or it will lose its purchasing power due to inflation. As such, people often look to put their money in relatively safe investments that provide liquidity to meet our spending goals.

There are essentially four main investments options that meet this criteria, while providing an investment return and low-risk of losing:

  • Certificates of Deposit (CDs)
  • Money Market Accounts (MMAs)
  • Savings Accounts (SAs)
  • Short-Term Bonds

Let’s take a look at each of these savings and investment vehicles.

Certificates of Deposit

CDs––a popular savings vehicle for many years––are savings certificates with a fixed maturity date and interest rate. CDs can have a range of maturity dates with long-term CDs typically paying higher interest rates than short-term ones. Additionally, most CDs are non-negotiable and therefore cannot be transferred, sold or otherwise exchanged during the holding period, but can be cashed in early by accruing an early withdrawal penalty fee. CDs can have maturity dates between just a few weeks out to several years.

Money Market Accounts

MMAs can offer another option as a savings account that pays interest. Generally speaking, MMAs pay a lower interest rate than CDs. The idea here is that you get a higher interest rate with a CD because you are forgoing some of your liquidity by tying the money up during the maturity period. With an MMA there could be a minimum balance and restrictions on the number of withdrawals you can make. As such, the best reason to typically use a MMA is when you might need immediate access to the funds.

Saving Accounts

Another comparison point is savings accounts, which tend to provide the highest level of liquidity as there are almost no restrictions on withdrawing your money or shutting down the account. However, savings accounts tend to offer the lowest interest rates when compared to bonds, CDs and MMAs. Today, with low interest rates in general, many savings accounts are paying almost nothing at traditional banks. However, some online institutions offer higher yield savings accounts today.

Short Term Bonds

Lastly, you can look at short term bonds as a solution. These are bonds that typically mature in one to three years. They still have some risk associated with them because the entity could default on its payments or interest rates could rise. If that happens and you try to sell your bond, the bond’s value could decline. However, if you hold the bond to maturity, you will get your principal back plus the interest. This is different than a bond-fund which has more risk and is even more closely impacted by changes in interest rates. In the end, bonds typically pay the highest interest when compared to CDs, MMAs or SAs, but also carry the most risk and least liquidity.

The Bottom Line

So when looking to save in a safe vehicle for a short duration, make sure you know the differences. CDs and short-term bonds offer the highest rates, but the most restriction on access to your funds. CDs, MMAs and savings accounts are likely federally insured.

While bonds don’t have the same type of insurance coverage, if you are purchasing a federal US bond, it still comes with a similar degree of safety. Municipal and corporate bonds carry more risk and pay higher interest rates. As such, be sure you can leave your money alone during the time period.

MMAs and savings accounts will offer lower returns but more immediate access to your funds. With MMAs compared to savings accounts, make sure you can meet the minimum requirements for the MMA and that there are no withdrawal limits.

If you want the most flexibility and access to your money, you can go with a savings account, but the interest rate will be low compared to other investments. Lastly, once you determine which account you want to go with, make sure you shop around as different institutions will offer different interest rates, fees and account minimums.