There is more to it than just withdrawal flexibility. Money markets and certificates of deposit are two popular options for people who want to earn interest on their cash savings (CDs). In essence, you are lending money to a bank when you purchase a certificate of deposit in exchange for interest payments. A similar source of passive income is provided by money market investments, which are divided into two categories: accounts and funds. While CDs guarantee an interest rate for the duration of the CD, these money market products offer more flexibility. Here is a comparison of CDs and money markets so you can decide which is best for you.
Main Points
- CDs almost always have a set maturity date and are FDIC insured.
- Money markets have no maturity date and are FDIC-insured.
- While money markets typically have variable rates, CD interest rates are typically fixed.
What Distinguishes Money Markets from CDs?
| Certificates of Deposit | Money Markets | |
| FDIC Insurance | Almost always | Yes |
| Timing | Has a specific timeline | Largely be able to deposit and withdraw money at will |
| Interest Rate | Usually fixed | Variable |
FDIC Protection
The FDIC typically insures certificates of deposit. Like money in your savings or checking account, the bank's promise to return the money is covered up to the $250,000 FDIC limit as long as the CD issuer is FDIC-insured. The owner of the CD will still receive their money back even if the bank fails. Money market accounts are typically FDIC-insured in the same way that savings accounts are, provided that the institution offering the account is also FDIC-insured. However, money market funds, which essentially function as a mutual funds with relatively safe bonds, are not. Money market funds do carry some risk, even though it is significantly lower than that of stocks, and it is possible to experience a financial loss.Timing
Timed deposits are CDs. That implies that the product is subject to a strict timetable. Before you put money into the CD, you are aware of the special day you will receive your money back. If you make an attempt to withdraw your money before that time, you might incur penalties. The typical timelines for CDs are between three months and several years. Choosing a CD with a longer timeline might result in higher interest rates, depending on the institution issuing the CD. The way interest is paid out on CDs varies as well; it may be done monthly, quarterly, annually, or all at once when the CD reaches maturity. Both accounts and funds in the money market operate more like regular bank accounts or mutual funds. Most of the time, you are free to deposit and withdraw funds as you please. Although there might be restrictions on how frequently you can withdraw funds in a given period of time, money markets generally offer much more flexibility.Interest Rate
The interest rate stays constant, just like a CD's fixed period of time. Before purchasing a CD, you are aware of the interest rate you will be paying for its entire duration. Advice: The amount of your deposit may affect the CD's rates. Jumbo CDs, as they are commonly known, are CDs that cost $100,000 or more and frequently have higher interest rates. On the other hand, money markets have variable rates that fluctuate in response to market factors. Depending on the general interest rate environment, your interest rate could go up or down.Money market accounts: Advantages and Drawbacks
Pros
- Simple to obtain sporadic payments from
- APY that could be higher than that of savings accounts
Cons
- For the best rates, you might need a sizable balance, like $100,000.
CDs' Benefits and Drawbacks
Pros
- For a longer-term commitment, higher rates are offered.
- If interest rates decline following your purchase, continue earning a high APY.
Cons
- Potential fees for withdrawals made too soon
- Risk of remaining with a low APY if rates increase after you purchase
Which One Fits You Best?
Money markets and CDs are two different products with distinct benefits. You can choose between them more easily if you know what matters to you the most.For planning, CDs Work Best.
CDs have specific conditions that are FDIC-insured. You can estimate your expected returns before investing because you are aware of your interest rate and tax bracket. Because the interest rates on money market accounts and funds change over time, this is not possible with them. Additionally, the interest rate on a money market account may vary depending on the balance, which means it may change as you make additional deposits or withdrawals. This makes CDs the perfect choice for those who want to prioritize capital preservation over growth.Money Markets Offer the Most Flexibility
Although CDs typically offer higher interest rates than money markets, your money is locked up for a number of months or even years. The risk of opportunity cost is present when choosing a longer maturity; the longer your money is locked away, the more likely it is that better opportunities will present themselves for it. Money markets are extremely liquid, and you can withdraw your money whenever you want without incurring any fees (as long as you don't do it frequently). The likelihood is high that your money markets will be accessible to you with a lot less hassle than a CD, barring a liquidity crisis or fund-specific catastrophe. Additionally, while changing money market interest rates may be unfavorable for some investors, it may not be for all investors. Money market accounts may be preferred by high-income or capital-rich investors since interest rates frequently rise as balances rise.The Best of Both Worlds
You are not required to pick between the two. You can diversify your savings by using both money markets and CDs. Let's say you have $2,000 in cash as an example. You know that you want to use $1,000 toward birthday gifts for your child, but you are unsure what to do with the remaining $1,000. If so, you could invest $1,000 in a CD that matures right before your child's birthday and keep the remaining $1,000 in a money market account until you come up with a plan for what to do with it. Alternately, you might be worried about obtaining the lowest interest rate possible and suspect that rates will rise in the upcoming months, but you are unsure. If so, you could invest the majority of your funds in money markets (to benefit from rate increases) while setting aside a small sum for a CD as insurance in case you're mistaken, and interest rates decline in the upcoming months.The conclusion
CDs and money markets are beneficial for those who want to generate passive income without investing in securities like tax-free municipal bonds or corporate bonds. A money market might be a better choice for people who require simpler access to their money. CDs are frequently a better option for your portfolio if you don't mind keeping your money locked up for a while. An investment advisor can provide the best guidance as to what is appropriate for your particular situation, as is the case with any financial decision.Most Commonly Asked Questions (FAQs)
A money market or a CD, which generates greater profits?
Interest rates on money markets and short-term CDs are frequently comparable, whereas rates on long-term CDs (with maturities of one year or longer) are frequently higher.Why is a CD better than a money market account?
The main perk is that a CD with a term of at least a year typically offers a higher interest rate than a money market account.Are CDs and money markets the same thing?
CDs are not the same as other financial products. Even though banks typically offer both, a CD has a set term and will probably charge early withdrawal penalties if you take your money out early. On the other hand, money markets don't impose penalties for early withdrawals and occasionally provide checking services.