subject: Invest In a CD Versus a Savings Account, When Does It Make Sense? [print this page] Invest In a CD Versus a Savings Account, When Does It Make Sense?
I've actually read quite a few articles on the opposite. Why invest in CDs when you can get a higher savings rate? The answer comes down to a few key points. But of course neither argument is completely right or wrong.
First, the main point for using CDs as an investment tool isn't the yield. Finding better yielding investments isn't actually that difficult. However, there is really no other alternative investment that gives as high a yield when safety is taken into account. So for background, you invest in CDs when you have funds that need to be kept safe and you can't afford to lose principal. Savings accounts of course protect your principal, too, but the yield on a savings account can change quickly.
Basically, in a falling rate environment you don't want to put your funds into a savings account because the risk to your rate is too great. People who had a 2.00% savings rate six months ago are now facing about 1.25%. If you had deposited your funds in a 1-year CD you would still be earning 2.00%. Now granted there may still be a special savings rate out there around 2.00%, but then you have to constantly be monitoring your rate and if it does drop, then you have to set-up an account elsewhere and get it transferred. Remember time is money, too.
Of course savings accounts are important, too. You need to keep some emergency funds in a very liquid and safe state. Savings accounts serve that purpose perfectly. For emergency funds, yield isn't really important. Having quick access and the funds protected are. So for those funds, look around and try to find a savings account that is consistently in the top 10. I don't believe you want to transfer your funds everytime there is a change in rates. If you can find one with a good track record, you will feel assured that at least you should always have a good savings rate when compared to others.
Also, in a rising rate environment, savings accounts may be better. However, keep in mind that while some banks will raise rates quickly others will hold off as long as possible, because the sooner they raise their rates, the more expensive the money is to the bank. They will probably hold off until they start seeing a max exodus of funds.
The other time to use CDs is when rates hit a level that doesn't happen all that often. In general, if you rates start getting above 4.50% to 5.00% you'll want to consider locking in some CDs for as long as you can. Rate levels like that don't usually last long. Trying to time the market just right usually results in missed opportunities. Lots of people back in 2007 locked in 1-year rates near 6.00% only to see the economy crash and burn, bringing us to levels of barely 1.00%.
Use CDs for the funds that need to be protected, but you don't need quick access to the funds. Overtime, you will have earned more than if you kept bouncing from one savings account to another.
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