Money Markets, CDs and Savings, What’s the Difference?

Often people ask me where I put my savings, do I use a Savings account? What about CDs and Money Markets? What’s the difference between all of these anyhow?

The amount of guaranteed interest you receive on any account is almost always relative to two things, risk (how likely you are to lose your money) and liquidity (how easy it is to access your money).

Most people have a checking and savings account. Both of these accounts are completely risk free. The government insures you up to $250,000, so there is almost no chance you’ll lose money you put into an FDIC insured checking and savings account. Because of that, traditional checking and savings accounts pay almost no interest at all. However, usually a savings account will pay slightly more interest then a checking account. Why? Because it’s slightly less liquid (you can’t draw checks on it, but you can still withdraw money at will).

Money Markets and CDs are the next level of FDIC insured accounts. A CD, or certificate of deposit, functions exactly like a savings account, but with one crucial difference: you have to commit to keeping the money in for a certain term. The longer term you choose, the more interest it will pay. The downside here should be obvious, you can’t touch your money if you need it (without a penalty). The upside is that the interest rate you commit to will remain, so if savings account rates go down, you’ll still be getting the previous interest rate.

A Money Market account is kind of a hybrid of all of the above. Money Markets typically pay higher interest then a traditional Savings account, but require a higher minimum deposit. Also, unlike a Savings account or CD, you can typically draft a limited number of checks from a Money Market account (6 per month is the federal limit).

So which should you use? I honestly see no reason why anyone should use a CD given current market rates. In times of high interest rates, I think a CD could be a good idea, but even the best CDs right now are paying only 1.5% for a 5-year CD. If interest rates go up anytime in the next 5 years, this is a bad idea (and it’s hard to picturing them going much lower). A smart combination would probably be some mix of the other three:

  • An interest bearing checking account, where you only keep the minimum amount of cash for your monthly cash flow needs (and also ensuring your bank’s minimum balance requirements)
  • A high interest Savings account which you can use for short term emergencies (say 2-3 months of income)
  • A money market for the rest of your longer term savings

I would almost certainly not use any traditional brick and mortar banks for Savings or Mutual funds, as right now they are paying no interest at all (almost literally). A quick comparison between a traditional bank like PNC and an online bank like EverBank as of today (assuming balances I described above):

PNC Bank EverBank
Checking 0.01% 0.82%
Money Market 0.09% 1.01%
CD 0.15% 0.81%

As you can see, traditional banks pay basically nothing these days, either their overhead costs are super high or they just prefer making money by giving you fees. If you are not earning money on your checking, I definitely recommend checking out EverBank as well (no pun intended).