Money Market Accounts vs CDs

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Contributor, Benzinga
December 19, 2022

Certificates of deposit (CDs) and money market accounts (MMAs) are excellent savings deposit options you can leverage to grow your money faster via interest earning. A high-yield savings account (HYSA) is another excellent option. Keeping a portion of your assets in cash or cash equivalents like CDs and MMAs makes sense for many reasons. 

A well-thought-out financial plan necessitates keeping an emergency fund equal to three to six months of your living expenses. Besides helping you fund short-term goals, these investments also provide opportunities to diversify your portfolio. CDs and MMAs are pretty similar and may seem interchangeable. Both offer low-to-moderate yields with relative stability and maximum peace of mind, making them attractive to risk-averse investors.

Nevertheless, they differ significantly in method or approach. And while your liquidity needs and specific objectives for the cash may ultimately influence your choice between CDs and MMAs, understanding their core differences can help you make better investment decisions. 

What is a Money Market Account?

Money market accounts (MMAs) are interest-bearing savings products that traditional and online banks and credit unions offer account holders. MMAs are a hybrid between checking and saving accounts. They allow investors to enjoy core savings account benefits while providing them with some checking account features. For instance, investors or account holders can earn interest on their balances like a savings account. The interest rate is often variable, fluctuating with changing market conditions, and typically higher than traditional savings accounts. 

Furthermore, like savings accounts, MMAs often come with a debit card, allowing account holders to make deposits, withdrawals and transfers via automated teller machines (ATMs). Like a checking account, MMA investors can write checks against their account balances which, combined with the availability of debit cards, makes it easy to access cash. Most financial institutions require an account minimum that must be maintained after account opening. And in line with the Federal Reserve's Regulation D, you're limited to six monthly withdrawals and transactions. 

Excess withdrawal charges or penalties may apply when you exceed the limit or your balance falls below a certain level. You may also have your MMA closed or converted to a checking account. The type of transactions affected by Regulation D encompasses ACH payments, bill payments directly from your account, debit card transactions or check payments to a third party and telephone, wire, overdraft and electronic fund transfers. Although the Fed lifted the withdrawal or transaction limit in April 2020, you should also look out for it, as most financial institutions still apply it. 

MMAs also provide investors with federal insurance protection, which helps reinforce trust between investors and financial institutions. The Federal Deposit Insurance Corporation (FDIC) insures MMAs held at banks, and the National Credit Union Administration (NCUA) insures those held at credit unions. Up to $250,000 worth of coverage is provided per depositor per bank, while joint accounts are covered for up to $500,000. If you have multiple insurable accounts (CDs, MMAs and HYSA), the $250,000 counts towards it.

What is a CD (Certificate of Deposit)?

CDs are time- or term-based deposit accounts or savings products that earn interest. Typically, the term length or duration ranges between three months to five years. However, it could be more depending on the bank or credit union. CDs can offer significantly higher interest than other flexible savings accounts (HYSA and MMA). Once you open a CD, you make a deposit that remains untouched throughout its entire term. You can neither withdraw nor deposit more money into the CD without incurring a penalty. 

By opening a CD, you accept to have your fund locked away for an agreed-upon duration during which the fund remains inaccessible. The financial institution can use your fund for investment or other purposes during the locked-in period. As an incentive for restricted access, you enjoy an interest rate somewhat higher than other savings accounts at maturity. A CD is the way to go if you're willing to sock away your money for a longer duration with zero risk. At maturity or the end of the CD term, investors can access their funds and the earned interest.

Depending on your preference and options provided by your financial institutions at maturity, you can: 

  • Roll over the CD into a new closely matching CD at the same financial institution 
  • Transfer the funds into a flexible savings option (HYSA and MMA) or checking accounts at the financial institution 
  • Directly withdraw the fund, transfer it to an external account or have it mailed as a paper check.

Either way, your financial institution will stipulate a deadline for you to provide instructions regarding what to do as the account matures. A CD offers predictability regarding expected returns from your investments since, unlike other savings accounts, it's unaffected by inflation or market turbulence. However, a penalty may apply when you withdraw the fund before the agreed-upon term. The penalty may involve deducting days or months of earned interest depending on the term length or complete forfeiture of the interest. 

Almost every consumer financial institution offers CDs. However, term lengths, interest rates and expected early-withdrawal penalties vary among institutions. Some financial institutions require high minimum deposits. Therefore, shopping around is crucial to finding the best CD deals, especially regarding interest rates. Similar federal insurance protection covering MMAs or other deposit accounts protects your investment in CDs. So, when you open a CD with NCUA- or FDIC- insured institutions, you qualify for up to $250,000 in insurance coverage provided by the U.S. government in case the institution fails. 

Differences Between Money Market Accounts and CDs

Despite serving essentially similar purposes, CDs and MMAs differ in various aspects. Some of their core differences are seen in the following. 

Interest Rate: CDs offer a significantly higher interest rate or annual percentage yield (APY) than MMAs or other savings deposits. For instance, according to the FDIC, the national average APY on 3-month to 60-month CDs ranges from 0.32% to 0.98% for deposits under $100,000. Rates vary among financial institutions. The nationally highest or best CD rates range between 3.75% for a 3-month term to 4.75% for a 5-year (60-month) term. In contrast, according to the FDIC, the average national MMA rate for November is 0.29% for investments under $100,000. Higher interest rates or APY amounts to higher returns, everything being equal. The interest rate for short-term CDs may be lower than that of the money market.

Liquidity: Money market accounts are considered liquid investments since you have full and unrestricted access to your fund anytime you need it. The 2020 lifting of the six-month withdrawal limit by the Federal Reserve makes it an even more appealing savings option. For instance, you can easily access your funds without penalties during a financial emergency. CDs are relatively illiquid investments, and withdrawals before maturity may attract stiff penalties. Although few financial institutions offer CDs without early-withdrawal penalties, the rates in such accounts make them unappealing.

Flexibility: MMAs make for excellent flexibility. The reason is that besides allowing unrestricted withdrawal, you can deposit or add more money to your account without consequences. CDs don't permit such flexibility. You cannot withdraw or deposit when you deem fit. Yield or interest earnings are distributed in fixed timescales — monthly, quarterly, annually or all at once during maturity. Fund withdrawal before maturity incurs penalties. One approach employed by investors to facilitate penalty-free withdrawal and increase interest earning is via CD laddering. This practice involves opening multiple CD terms with a varying maturity dates and APY.

Macro- and micro-economic Impact: The interest rate for CDs is fixed when locked in and so remains unaffected by macro- and micro-economic situations like inflationary and deflationary pressures. This factor characteristically makes yields or returns from CDs easily predictable. In contrast, interest rates on MMAs fluctuate as the market rises and falls.

Target investors: CDs and MMAs also slightly differ in their target investors. CDs target investors saving for a specific future project. This could mean a down payment for a house, college tuition, cars and people prone to spending money. In contrast, MMAs are ideal for investors who require regular passive income or those saving for unforeseen emergencies.

Similarities Between Money Market Accounts and CDs

CDs and MMAs are similar in more than a couple of ways. Some of these include:

Risk Potential: Like other savings account options, CDs and MMAs are low-risk investment offerings for risk-averse investors seeking a safe means to earn long- or short-term passive income. Low-risk investments of such types make for maximum peace of mind. 

Low yields or returns: Their inherent low risk means that the reward for this type of investment is considerably low. Although CDs offer better rates than MMAs, it is still generally low compared to other investments. High-yield investments like individual stocks and corporate bonds are considerably risky — an excellent price if you hope to accumulate wealth. 

Federal insurance protection: Like most savings account investments, CDs and MMAs are protected by up to $250,000 worth of insurance coverages per depositor per bank provided by the federal government. Joint accounts can enjoy coverages of up to $500,000. Bank-held accounts are insured by FDIC, while NCUA insures accounts held by credit unions. The implication is that during bank failure, your investment remains unharmed. 

Although banks rarely fail, you should ensure you're investing in a bank or credit union under FDIC or NCUA coverage. Most financial institutions are under these umbrellas, but a few use private insurance companies. If you want to deposit cash over $250,000 in your CD, you can split it into multiple accounts to stay covered. 

Portfolio diversification: Both account types can provide an excellent means to diversify your investment portfolio while funding your short-term goals. A mix of low-risk portfolios offering low-to-moderate returns and a high-risk portfolio offering high-return makes for an ideal diversified portfolio. Diversification ensures that the investor has something to lean on during market turbulence.

Compounding Interest: The interest rate on CDs and MMAs compounds over time. Your earned interest is periodically added to your principal or original capital. Subsequently, the total amount of the new principal will earn interest of its own, and the compounding continues. For clarity, interest rate differs from the APY, which is the amount you earn annually, taking into account compound interest. In contrast, the interest rate is the fixed rate you receive. The way the interest rates compound annually or monthly can impact your returns.

Simplicity: These are simple investments, and that’s often enough for the nervous or novice investor. If you want to know what your money can do, you can start here. Plus, these are investments you can continue to use as you expand your portfolio in the future.

Who Should Invest in CDs?

CDs are ideal for planning. If you don't have an immediate need for cash or your focus is on capital preservation other than growth, you can lock your money away in CDs. CDs offer  better rates and predictable returns that can help you fund long-term projects within 5 to 10 years. These needs could range from a down payment for your new home to financing your child's education. If you're prone to spending and find the money market too flexible, you can opt for CDs.

However, while CD can help you avoid long-term price fluctuations of market-based investments like stocks and mutual funds, you must also consider the disadvantages. Locking away funds for an extended period means you can't tap into new investment opportunities that may arise. The inherent illiquid nature of CDs is a disadvantage in a rising rate environment since your rate is already fixed. As a remedy, go for short-term CDs when you think rates will rise. You can also leverage laddering to minimize illiquidity.

Who Should Invest in Money Market Accounts?

MMAs offer flexibility from a liquidity standpoint. They are ideal for people with a recurring immediate need for cash or who want to save for emergencies. For instance, CDs won't be practical if your car engine blows up or you experience major domestic accidents requiring quick cash because of the early-withdrawal penalty. An MMA fits best in such scenarios. If you have short-term purchase plans from appliances to fashion, go for an MMA. 

Furthermore, an MMA can also be a practical choice in a rising interest environment since banks often adjust the yield upward during such periods, meaning you can earn more. The fluctuating interest rate that characterizes MMAs may only be a turn-off for some investors. High-income investors with significant capital may prefer to go with an MMA since the rate increases as the balance grows. MMAs may also suit young investors looking to store their down payment or build emergency funds. Older investors can leverage it to earn regular passive income. 

Frequently Asked Questions

Q

What is the downside of a money market account?

A

The downside of the money market account includes excess withdrawal or transaction charges and low and variable interest that fluctuate with the market conditions. However, the 2020 lifting of the withdrawal and transactions limit by the Federal Reserve means you can conduct transactions as much as you want. You can confirm with your financial institution if such charges still apply to be sure. 

Q

Is it smart to put your money on a CD?

A

Yes, CDs may offer higher rates than other savings accounts and can be an ideal way to save and to earn interest if you don’t have a short-term need for money. 

About Chika Uchendu

Chika Uchendu is a personal finance writer passionate about helping people learn more about managing their finances, making informed decisions, and navigating the complex landscape of finance platforms to find the best options for their financial goals and needs. He has over 8 years of experience writing compelling articles for various reputable publishers across diverse topics. When he’s not writing content, he’s wrangling and analyzing data to help businesses make informed decisions.