Today, there is a wealth of financial products available to those interested in saving money or investing it in order to steadily grow their wealth. But investing can be intimidating to those who are risk-averse or aren’t well-versed in financial markets. Fortunately, there are plenty of safe and low-risk options available to savers that can help them achieve their goals.
Since the Federal Reserve began its interest rate hiking cycle in March 2022, numerous savings accounts and savings products have increased their rates significantly. Because of this, there has been a surge in popularity for both high-yield savings accounts (HYSAs) and certificates of deposit (CDs), which you can use to make your money work for you.
Read on to learn more about HYSAs and CDs, how they work and which one is a better fit for your savings goals and personal finance objectives.
High-yield savings accounts vs. certificates of deposit
An HYSA and a CD are both savings vehicles that offer a high annual percentage yield (APY), which is the real rate of return in a given year based on interest rates and compounding interest. When compared to what you would receive from a traditional savings account, both HYSAs and CDs allow you to grow your money faster.
Despite their similarities, there are numerous differences between the two. The following section details what each one is and how it works.
What is a high-yield savings account?
An HYSA is a type of savings account that pays better-than-average interest rates and compound interest. In some cases, these accounts feature rates that are 10 times the national average for traditional savings accounts.
Most HYSAs are offered by online financial institutions. Because these types of banks and credit unions don’t face the cost of maintaining physical locations, they are able to pass those savings along to customers in the form of higher interest rates for their savings and checking accounts.
One thing you’ll notice about the best high-yield savings accounts is that they tend to not charge monthly fees. Additionally, HYSAs allow you to allow you to easily access your money, but they can have limits on how many withdrawals you can make per month.
How high-yield savings accounts work
The driving force behind HYSAs is the high interest rate combined with compound interest. Whereas simple interest is calculated just on the principal amount, compound interest is calculated on both the principal amount and previous interest received. This allows your savings account balance to grow much faster, especially when combined with a high interest rate. HYSAs use variable interest rates and are subject to change at any time without notice at the bank or credit union’s discretion.
The frequency at which the interest is compounded depends on the bank or credit union that provides the account. Some compound monthly, but many HYSAs compound daily. Typically, that accrued interest is added to the account balance once a month.
What is a certificate of deposit?
Like a HYSA, a CD is a type of savings account available at most banks and credit unions. However, unlike a HYSA, you agree with the financial institution to keep your money in the CD for a predetermined period of time without withdrawing it until the maturity date. CDs will typically charge you an early withdrawal fee as a penalty for accessing the funds before the maturity date.
Because customers’ funds are committed for a fixed term, the best CD rates tend to be slightly higher than those offered by HYSAs.
How certificates of deposit work
CDs function similarly to HYSAs with compound interest occurring at regular intervals. However, whereas HYSAs typically compound daily, CDs can compound daily or monthly. Earned interest is usually applied to your account monthly.
CDs offer savers fixed interest rates, which can be a blessing and curse. You lock in a CD’s rate for the entire term, even if interest rates in general decline. But if rates increase after you’ve committed to a CD, in order to take advantage of the new rates, you’ll either have to wait until the maturity date to withdraw the funds or pay an early withdrawal fee.
Because they use fixed interest rates, CDs and so-called “high-yield CDs” provide predictable and guaranteed returns.
Pros and cons of high-yield savings accounts
Like any financial product, HYSAs have their advantages and disadvantages. The following section discusses both.
Pros
- Higher liquidity than CDs
- FDIC-insured
- Daily compound interest
Cons
- Variable interest rates
- Lower APY than CDs
- Transfer and withdrawal limits
Pros and cons of high-yield savings accounts
Higher liquidity than CDs
Because they aren’t subject to fixed terms, HYSAs offer higher liquidity than CDs. Though some financial institutions may impose withdrawal limits, HYSAs don’t have early withdrawal penalties and you can access your funds at any time.
FDIC-insured
CDs are considered low risk because they are typically FDIC-insured. The Federal Deposit Insurance Corporation protects up to $250,000 in deposits for individuals, or $500,000 for joint accounts. Because the FDIC only applies to banks, credit unions have their own insurance provided by the National Credit Union Administration. HYSAs offered by credit unions are NCUA-insured at the same amounts allowed by FDIC insurance.
Daily compound interest
Most HYSAs compound interest daily, allowing you to earn the highest APY based on the variable interest rate at that time. Some regular savings accounts only compound interest monthly or quarterly while also providing inferior interest rates.
Cons of high-yield savings accounts
Variable interest rates
HYSAs offer variable interest rates. While this can be a positive if rates were to increase, they can also decrease at any time without notice. This makes calculating interest and potential gains more difficult than with a savings product that offers fixed interest.
Lower interest rates than CDs
Because your funds are accessible at any time without penalty, HYSAs tend to offer lower interest rates than CDs, because the money used to purchase CDs is committed for a fixed term. Banks and credit unions offering CDs make up for that inconvenience by offering higher rates.
Transfer and withdrawal limits
In 2020, the IRS suspended its Regulation D limit of six transfers or withdrawals per month for savings accounts. However, some banks and credit unions still enforce the rule for their customers. In those instances, exceeding six transactions per month can result in you incurring penalty fees.
Pros and cons of certificates of deposit
Just like HYSAs, CDs have their benefits and drawbacks. The following section discusses both.
Pros
- Fixed interest rates
- Higher APY than HYSAs
- FDIC-insured
Cons
- Lower liquidity than HYSAs
- Interest may compound monthly
- Early withdrawal penalties
Pros of certificates of deposit
Fixed interest rates
Fixed interest rates make CDs more predictable than HYSAs, as you can calculate exactly what your return will be upon maturity. CDs offer you the chance to lock in higher rates because your money is committed for a set term.
Higher interest rates than HYSAs
Because CDs tie up your money for a fixed term and come with early withdrawal penalties, banks and credit unions make up for that inconvenience by offering higher interest rates than you would get with a HYSA.
FDIC-insured
Like HYSAs, most CDs are FDIC-insured or, for CD accounts with credit unions, NCUA-insured. This makes them a low-risk savings option, with protection of up to $250,000 for individual accounts or $500,000 for joint accounts.
Cons of certificates of deposit
Lower liquidity than HYSAs
Whereas the money in a HYSA can be withdrawn just like a traditional savings account, funds committed to a CD are intended to remain there for the length of the term. CDs have varying term lengths, with short-term CDs beginning at three months and longer-dated CDs offered in five- and 10-year options.
Early withdrawal penalties
If you do need to access your money in a CD before the maturity date, you’ll likely face early withdrawal penalties, which can significantly erode your returns. These penalties typically entail you forfeiting a specified amount of your accrued interest. Depending on the length of the CD term, that penalty can range from 60 days of interest for short-term CDs to 90 to150 days of interest for other CDs. In some instances, banks and credit unions offer no-penalty CDs, but they are uncommon.
Interest may compound monthly
While some CDs offer daily compounding interest like most HYSAs, most CDs compound interest monthly, and in some cases, quarterly. The more often interest compounds per year, the higher the return on your money. Therefore, with CDs that compound interest monthly or quarterly, you would be losing out on potential growth of your funds compared to a savings product with a similar interest rate that compounds daily.
How to choose between a high-yield savings account and a CD
Choosing between a HYSA and a CD comes down to your personal savings goals. One consideration is the amount of time you want your money to be held in the account. If you have short-term goals or are looking to establish an emergency fund that benefits from a high APY and is easily accessible, a HYSA may be the better choice.
If you have longer-term goals, want a higher APY and lower liquidity doesn’t bother you, a CD could be better suited for your needs. CDs also come in shorter-dated maturities; however, the funds committed to them still face the same liquidity issues as longer-dated CDs.
If you’re unsure of which path to take, you can speak with a financial advisor who may present the options with more clarity.
How to open a high-yield savings account or CD
The first step in opening an HYSA or CD is to find banks or credit unions offering the savings products. Ensure that the HYSA or CD offered by the bank or credit union is FDIC-insured or NCUA-insured.
After narrowing down the list of financial institutions, evaluate how the available APY compares to competitors. After finding the strongest APYs for accounts at FDIC- or NCUA-insured institutions, analyze the minimum deposit requirements, minimum balance requirements and any fees associated with the HYSAs or CDs.
Once you’ve decided on a bank or credit union, apply for the HYSA or CD account, link your existing bank account from where the funds will be pulled and provide the initial deposit. Once the account is funded, you can set up automatic or direct deposits, name beneficiaries and opt to receive account alerts.
High-yield savings account vs. CDs FAQs
How are high-yield savings accounts and CDs taxed?
Interest earned from either an HYSA or a CD is treated as taxable income by the IRs. Therefore, any interest earned in a calendar year will be taxed at the same rate as your other income.
Are high-yield savings accounts or CDs fixed-income investments?
HYSAs have variable interest rates, so they are not considered fixed-income investments. On the other hand, CDs offer fixed interest rates with predictable and recurring interest payments, making them fixed-income investments.
What are the longer terms for a CD?
Long-term CDs range from two-year maturities to 10-year maturities. Longer-term CDs can be good savings options if interest rates are high and you don't need to access the money in the account until maturity.
Summary of Money's High-Yield Savings Account vs. CDs: What’s the Difference?
If you’re looking to make the most of your money without risking it in investments like equities, HYSAs and CDs are two virtually risk-free savings options that benefit from compound interest. Both can provide you with strong APY for both short- and long-term goals.
Depending on your overall objectives and your investment horizon, you may be drawn to one over the other. Bottom line: If your financial goals are safety-oriented savings with very little risk, both HYSAs and CDs offer you higher interest rates than you would get leaving your money in a regular deposit account.
