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High yield savings accounts vs. CDs: Which should I choose?

Key takeaways

  1. High-yield savings accounts offer flexible access to funds with higher interest rates than traditional savings, making them ideal for emergency funds and short-term goals

  2. CDs provide locked-in interest rates and potentially higher returns but require committing funds for a set term with possible penalties for early withdrawal

  3. Both options typically are FDIC-insured, and savers can use both simultaneously to help with different financial goals

There are several ways to store your money safely while still earning interest. Two popular options are high-yield savings accounts and certificates of deposit (CDs).

Both pay interest and both provide good risk management, but which strategy is right for you? To find out, let's take a detailed look at high-yield savings accounts vs. CDs.

What is a high-yield savings account?

High-Yield Savings Accounts (HYSAs) are savings accounts that pay higher interest rates than traditional savings accounts.

What is a CD?

Certificates of deposit, or CDs, are financial products like a savings account. They typically offer fixed interest rates, often greater than the rates that regular savings accounts provide.

The typical CD requires the consumer to deposit a fixed amount of money for a set term, or maturity period. If funds are withdrawn before the CD's maturity date, there may be financial penalties.

The power of compound interest

Compound interest is the key to the yields of HYSAs and CDs. The interest earned each month, or each day, is added to the principal, and the next interest payment is based on the new balance. The higher the interest rate and the longer the money is left in the account, the more powerful the compound interest becomes.

CDs let compound interest do its work by incentivizing depositors to leave their money untouched until the CD matures. HYSAs harness the power of compound interest through their higher interest rates, while allowing access to the deposits.

Pros and cons of CDs

Let's take an in-depth look at CDs:

Pros

  1. Locked-in interest rate. With their fixed returns, CDs are more predictable than HYSAs. A fixed-rate CD can serve as a buffer against market volatility 

  2. Higher returns. CDs tend to have higher interest returns than regular savings accounts. They might also have higher rates than high-yield savings accounts, depending on the term and the amount deposited

  3. Steady and stable. With CDs, your money is federally protected, so there's no default risk. And CDs aren't subject to short-term fluctuations in the stock and bond market

Cons

  1. Early withdrawal penalties. Withdrawing money from a CD before it matures may incur an early withdrawal penalty. The penalty could even eat into your principal

  2. Limited access to funds. Until the CD matures, you don't have easy access to the money. Even No-Penalty CDs may have restrictions on withdrawals

What's best for you? HYSA or CD?

There are several points to consider when deciding whether a HYSA or CD is best for you.

  1. Think about your financial goals and timeline and how much you're looking to earn compared to how long you're willing to leave your money untouched

  2. Choose a high-yield savings account for flexibility, for easy access to funds, and for building an emergency fund

  3. Choose a CD if you want a fixed return that's not influenced by financial markets

The best part is you don't have to choose just one. Savers might use a high-yield savings account for an emergency fund while also depositing money in a CD for long-term savings.

FAQs

Your earnings with either option depend on several factors. High-yield savings accounts have variable rates, so the interest rate you start with as you try to calculate the difference in earnings could change over time. And you can't tell which direction rates will go.

With CDs, banks might offer different interest rates depending on how long the term is or how much money you deposit.

To get a rough answer to this question, you could determine how long you might put the money in a CD and how much money you could commit. Then you could compare the best rate you could find for that amount and period of time to the best rate available for a high-yield savings account.

If you're working with a bank insured by the Federal Deposit Insurance Corporation (FDIC), both have equal protection if a bank fails. With FDIC -insured banks, deposits are covered at least $250,000 per depositor, per insured bank, per ownership category.

Looking beyond the issue of FDIC insurance, the short answer is "probably not," but there are caveats.

If you withdraw funds from a CD before maturity, you'll likely be charged a penalty. Such a penalty is often calculated as a percentage of the total interest you would have earned. If you don't accrue enough interest before the withdrawal to cover the penalty, it could eat into the principle, and you would lose money.

Some specialty CDs, such as Brokered CDs and Foreign Currency CDs, also could lose money, although they can present an opportunity for high rewards.

If you're considering a high-yield savings account with monthly fees, think about how much those fees could eat into your earnings.

This article is for general informational purposes only. It is not intended to provide specific financial, investment, tax, legal, accounting, or other advice and should not be acted or relied upon without the advice of a professional advisor. A professional advisor will recommend action based on your personal circumstances and the most recent information available.

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