Published in: Banks | Jan. 21, 2019

Money Market vs. CD Accounts: How to Choose

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These are two great options for maximizing returns from your cash, but there are some big differences between them.

A neat row of hundred dollar bills.

Image source: Getty Images

There are several places you can choose to park your cash. If you plan to use your cash for day-to-day expenses, a checking account could be the smartest way to go. If you want to save money for a decades-long period of time, a Treasury bond or savings bond could be a better choice.

If you have cash that you don’t need for day-to-day expenses and you’d like to earn interest from, two options include money market accounts and certificate of deposit, or CD accounts. While there are several similarities between the two accounts, such as generally higher interest rates than bank savings accounts, there are also several important differences you should be aware of before deciding.

What is a money market account?

A money market account is similar to a savings account, but banks tend to use them for slightly different purposes. While savings account balances are typically used to fund loans to the bank’s other customers, money market funds are used to make short-term investments by the bank, such as in Treasury securities.

Money market accounts typically pay slightly higher interest rates than standard savings accounts. As of this writing, FDIC data shows that the average money market account pays an interest rate that is six basis points (0.06%) higher than the average bank savings account.

Generally speaking, money market accounts have stricter requirements than savings accounts when it comes to initial and ongoing account balances. Like savings accounts, money market accounts are also limited to six withdrawal transactions per month (penalties apply for excess withdrawals) by the Federal Reserve’s Regulation D.

What is a CD?

A CD is a type of savings account that requires the account owner to leave their funds deposited for a specified amount of time. For this reason, a CD is also referred to as a time-deposit account.

CDs pay a fixed interest rate from the date of deposit through the maturity date, at which point the account’s entire balance is generally required to be withdrawn. CD terms most commonly range from three months to five years, although longer or shorter terms aren’t unheard of.

Most institutions require a minimum balance to open a CD, although some online banks have done away with this requirement. Also, the minimum balance to open a CD is often less than the minimum required to open and maintain a money market account.

Key similarities

  • Money market accounts and CDs both tend to pay higher interest rates than standard savings accounts.
  • Money market accounts and CDs are both FDIC-insured deposit products. Both are insured up to $250,000 per depositor, per institution. If your account is held at a credit union, there is a different form of deposit insurance, but with the same limitations.
  • Both account types tend to have substantial minimum balance requirements when compared with standard savings accounts. For example, Wells Fargo requires a $2,500 minimum deposit to open a standard CD account, while just $25 is required to open a savings account with the bank.

Key differences

  • A CD requires that the account owner commit to leaving the funds deposited for a specified amount of time, and early withdrawals are typically subject to a penalty. For a longer-term CD, this penalty can be as much as one year’s worth of interest. On the other hand, money market deposits can be withdrawn at any time, although there are restrictions governing the frequency of withdrawals.
  • CDs don’t allow for partial withdrawals, even in early withdrawal situations. The entire balance must be withdrawn at the same time. Meanwhile, if you deposit money into a money market account, you can withdraw only the amount of money you need. For example, if you have $5,000 in a money market account and need $100 to cover your electric bill, you can simply withdraw $100. If your only cash was $5,000 in a CD, you’d have to withdraw the entire amount to access your money and you’d pay a penalty on the entire amount, even though you didn’t even need $4,900 of it.
  • CDs generally pay higher interest rates to incentivize consumers to commit to leaving the money in the bank for a certain amount of time, and longer maturity periods tend to have higher interest rates.
  • Money market interest rates can potentially rise along with market interest rates. CD interest rates are fixed for the account’s term. This interest rate risk can be somewhat mitigated by creating a CD “ladder,” which means utilizing several CDs of staggered maturity dates instead of just one longer-term CD.

Comparing interest rates

As mentioned, money market accounts and CDs tend to offer higher interest rates than standard savings accounts. However, these can vary dramatically by institution, especially when comparing traditional brick-and-mortar banks to newer online-based institutions.

To give one example, the national average interest rate on a five-year CD is 1.16% as of this writing. Meanwhile, it’s easy to find five-year CDs with reputable online-based financial institutions with rates of more than 3%. If you deposit $5,000 into a five-year CD, this translates to about $500 more in interest over the term. It’s tough to over-emphasize the importance of shopping around for the best CD rates and best money market rates when shopping around for a new account.

It’s also important to mention that some online banks don’t offer money market accounts but have high-yield savings accounts that might pay even more. For example, Marcus by Goldman Sachs doesn’t specifically offer a money market account, but the 2.05% APY paid by its high-yield savings product (as of Nov. 6, 2018) is tough to beat by all but the best money market account interest rates. So, if you decide that a money market account is right for you, be sure to check out the best online savings accounts when comparing rates.

What’s the best choice for you?

Keeping some of your assets in cash is always a smart idea. If you’re sitting on some cash that you’re pretty sure you won’t need for a while, a CD account will generally allow you to get the best yield. For example, if your child is going to college in three years and you want a risk-free place to park their college savings in the meantime, a three-year CD could be an excellent combination of safety and yield.

However, keep in mind that a CD comes with early withdrawal penalties attached to it, and probably won’t permit you to take a partial withdrawal if you only need some of the money.

For these reasons, if you have some emergency savings you want to be able to readily access without penalty, or you may need the money to cover some of your living expenses, a money market account or high-yield savings account is probably the better option for you.

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