Looking at the pros and cons of Money Market Accounts and CDs
If you’re between your 20s and early 30s, you must make solid financial choices. One such choice involves which type of bank account (or accounts) you should open to reach your savings goals.
What Is a Money Market Account (MMA)?
According to the Consumer Financial Protection Bureau (CFPB), an MMA is an interest-bearing savings account offered by banks and credit unions. You get a hybrid between a savings and a checking account, which makes it unique. Like standard savings accounts, it limits your free transactions to 6 per month. The bank invests your money in safe investments, and you get a small percentage of their return.
Benefits of MMAs
Before we go into the benefits of MMAs, note that you want to get an account with the highest possible APY.
In case you don’t remember, APY stands for Annual Percentage Yield. Your account earns money both on your deposits and on previous interest, since interest compounds with time. The APY on MMAs and savings accounts varies, so if the market plummets, it’ll bring your APY down.
A money market account can earn you anywhere from 0.20% to 1% APY. For example, if you have an account with a $7,000 balance and a 0.40% APY, your yield for 2 years would be $56.
You get a much higher APY than your average checking account and about the same as you’d find with a high-yield savings account (more on that later). Online banks tend to provide the highest APYs across every type of account when compared to traditional brick-and-mortar banks. Low overhead costs allow them to achieve this.
Unlike a savings account, an MMA comes with a checkbook and sometimes a debit card, meaning you get more access to your principal.
Either the FDIC or the NCUA insures your MMA’s balance for up to $250,000. It depends on where you’ve opened your account (in a bank or a credit union).
So, if things go south and your financial institution goes belly up, you’ll get back up to $250,000 of your balance. The $250,000 limit applies per account depending on the ownership account, not just per account. See the FDIC’s page for additional information. Rest assured, you’ve got a safe place to put your money.
Downsides of MMAs
While MMAs give you a couple of unique benefits, they come up short in other areas. Money market accounts used to net you a higher APY than high-yield savings accounts. Due to all-time low-interest rates, that’s not the case anymore. And while there are a couple of credit unions that offer an APY of 1%, they are exceptions, so keep that in mind.
On average, MMAs require a higher opening deposit and minimum balance than high-yield savings accounts ― while not necessarily offering a higher APY.
Also, the opening deposit for an MMA usually varies anywhere from $100 and $2,500.
Regarding minimum balances for MMAs, they can range from $100 to $50,000, depending on the bank or credit union ― the higher the APY, the stricter the requirements.
Speaking of requirements, make sure you understand all the fees for:
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Keeping your account
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Not maintaining a certain minimum balance
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Exceeding transaction limits
As with everything, do your research to avoid surprises down the road.
What Is a Certificate of Deposit (CD)?
According to Investor.gov, a CD is a savings account that holds a fixed amount of money for a fixed period. As compensation, the issuing bank or credit union pays you interest.
The fixed periods can range from 30 days to 10 years. As you can expect, the longer the maturity period, the higher the APY you’ll get. The longer you abstain from withdrawing your principal, the higher your return will be.
Benefits of CDs
CDs can be one of the best savings vehicles for young adults.
Let’s go over some reasons why:
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They offer up to three times as much as high-interest savings accounts and MMAs, especially long-term.
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They are the perfect choice for those who want to store money away and have no immediate need to access it.
More importantly, CDs offer a great way to grow your savings during your 20s, when you have the most energy and hunger to achieve these goals.
Most importantly, discipline makes the CD the pillar to growing your savings, not the higher APY (not that high anyway).
When you adopt the mindset that the money in your CD doesn’t exist until its maturity period, a few things happen:
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You become more intentional with your money.
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You avoid sabotaging your progress with impulsive withdrawals.
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You reach your goals faster.
A savings account should make it as hassle-free as possible to achieve your financial goals. Tell yourself you don’t have that money from the beginning. After all, you can’t spend something you don’t have.
If the fear of a penalty removes the temptation to withdraw altogether, the CD has achieved its purpose. If you can get a decent APY on top of that, it seems like a no-brainer. Of course, this works as long as you don’t need to access that capital soon. If you do, get a high-yield savings account or an MMA.
Remember, CDs work better as long-term savings accounts. Certificates of Deposit also carry FDIC and NCUA insured for up to $250,000 of your combined deposit amounts in a bank or credit union.
Additionally, a CD locks in your APY, unlike MMAs and high-yield savings accounts whose APYs can change at any time without notice. So, even in the event of a recession, your APY on the CD remains the same.
Downsides of CDs
CDs provide a much more restrictive kind of savings account because you’ll get penalized for withdrawing money before the certificate’s maturity date, also known as an “early withdrawal.” The penalty you’ll face will depend on your institution as well as your CD’s maturity date, but it can vary anywhere from 60 to 365 days’ worth of interest.
How they calculate your penalty also varies between institutions. A common minimum penalty sets you back $25. That $25 will come from your earned interest. If the penalty is higher than that interest, the institution covers this cost with your principal instead. That’s the last thing you want to happen.
Unless interest rates skyrocket, you shouldn’t withdraw your money early. If that happens, though, consider withdrawing early to get a substantially higher APY elsewhere.
To know if you should trigger the early withdrawal penalty, do the math:
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Calculate how many months of interest you’ll have to pay.
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Figure out if the new APY will earn you more over the same period
For example, if you’ve got a penalty of 6 months of interest on a 1% APY, will you earn more than that during the first 6 months of your new CD’s APY? Confused? Here’s a CD penalty calculator.
Also, the minimum deposit for a CD typically hovers around $500, although it can be much higher.
Ironically, one drawback of CDs is that if interest rates rise in the future, you’ll be stuck with a lower APY because it’s locked. You can prevent this through a CD ladder. With a CD ladder strategy, you deposit money into many CDs, each with a different maturity date.
That way, you can withdraw funds from your short-term CDs where penalties will be much lower and get a greater interest rate. At the same time, you still hold some money on the interest rate you locked in before, in the event rates suddenly plunged.
Should you get a CD or an MMA?
It all boils down to your situation. If you want to build your savings and enjoy checking account features like a debit card or a checkbook, an MMA might make sense for you.
If all you need is a savings account that earns you a good APY, a high-yield savings account will do the trick. You’ll find more options for this type of account in the market.
However, if you just want to stash some money away, start saving towards a long-term goal, and get a higher APY, go with a CD.
In either case, you should look for an account that provides you with:
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No monthly fees
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A high APY
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Low penalty fees
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FDIC or NCUA insured
Remember, these accounts won’t fund themselves. So if you don’t regularly contribute to them, you won’t reach your goals.
Action steps
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Set clear financial goals
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Understand your immediate financial needs
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Get an account tailored to those goals and needs
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Start contributing money to your account
Wrapping up
Money market accounts and certificates of deposit are financial products that can work very well for young adults wanting to save money.
Unless you only want access to a checkbook and a debit card, a money market account won’t bring much more value than a high-yield savings account.
A CD, however, is a must-have account during your 20s and early 30s. Mainly because banks designed it to keep you disciplined. Don’t underestimate this perk since you may not have figured out your financial life yet.
After reading this post, you should have a better idea of which banking product makes the most sense for you.
