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A money market account (MMA) and a certificate of deposit (CD) are two financial products that generate interest income from cash savings. Both products can be thought of as fixed-income investments, like bonds, that provide predictable interest over a defined timeframe.
As such, CDs and MMAs are excellent options for investors looking to supplement their pre-retirement portfolio, build an emergency fund, or simply save for a down payment. The versatility and relative safety of these fixed-income investments are perhaps their most attractive assets for investors looking to get a jump on their savings goals.
Let’s take a look at both savings vehicles to see how they compare and to determine which one might be the better option for your financial situation.
MMA and CD: What’s the Difference?
Money Markets 101
Money market accounts are interest-bearing savings accounts offered by banks and credit unions that often pay a higher interest rate than high-interest savings accounts and offer insurance protection. Unlike CDs, MMAs provide investors with debiting and check-writing privileges.
MMAs generate higher interest rates than savings accounts because the former are permitted to invest in government securities and unsecured short-term debt issued by corporations.
For these reasons, MMAs are tools for strategic wealth preservation for those interested in diversifying their portfolio while hedging against inflation risk.
Certificates of Deposit 101
CDs have a defined maturity date typically ranging between three months and five years, as well as a stated interest rate. Usually, a penalty is levied if funds are withdrawn from a CD before maturity.
A CD is, in essence, a financial product that allows a bank to hold your money for a fixed period of time. Because the bank is guaranteed access to your money, they are typically offered at a higher interest rate than money market accounts.
CDs are often sought after by investors looking to earn more interest versus a high-interest savings account while still wanting to keep their money insured.
Benefits of Money Market Accounts
Safety and Risk Profile
Money market accounts are considered safe, low-risk investments because they are protected by the U.S. federal government. Every money market account in the U.S. is insured by the federal deposit insurance corporation (FDIC), which means your money will be returned to you even in the event that the issuing financial institution declares bankruptcy. However, only the first $250,000 per depositor is insured by the FDIC—every dollar above that threshold is uninsured.
Check-writing and Debit Cards
Much like an ordinary savings account, MMAs allow depositors to write checks and make retail purchases with a debit card.
Compound Interest
MMAs pay a compound interest that’s calculated on a daily basis and distributed monthly. In other words, the issuing financial institution will pay out a sum determined by the original amount of money invested as well as the interest already earned.
To get a better idea of how compound earnings work, let’s take the example of an MMA that pays an annual interest rate of 3% on a $100,000 account. Every month, the amount of interest earned increases as the interest is reinvested (“compounds”) in addition to the original deposit.
- 1st Month Interest = $100,000*0.03/12 = $250.00 interest
- 2nd Month Interest = $100,250*0.03/12 = $250.62 interest
- 3rd Month Interest = $100,500.62*0.03/12 = $251.25 interest
- 4th Month Interest = $100,751.87*0.03/12 = $251.88 interest
Benefits of Certificates of Deposit
Federally Insured Return
When investing in a CD, the return of your money is more important than the return on your money. Unlike equities, mutual funds, or ETFs, CDs are backed by the full faith and credit of the U.S. government up to $250k ($500k for joint accounts). FDIC coverage of your principal investment is tantamount to investment insurance subsidized by the lender.
Predictability and Personalization
CDs offer various term lengths to suit investors’ individual investment horizons (usually between 6 months and 5 years) at a fixed interest rate. These terms allow investors to forecast their earnings over the lifetime of the deposit.
The CD Ladder
Some investors choose to spread their money across several CDs with various maturity dates. This creates a “CD ladder” in which your cash becomes available in intervals.
The main benefit of a long-term CD ladder is that investors can take advantage of multi-year CDs, which usually offer higher interest rates, without having all of their savings unavailable in the long-term. To keep the CD ladder operating in perpetuity, investors can open a new five-year CD (2.75% APY) upon the expiration of every 12-month CD (2.50% APY).
Disadvantages of MMAs and CDs
Despite their many respective benefits, there are several disadvantages associated with MMAs and CDs. Below, I’ve listed the various drawbacks to both savings accounts.
Certificates of Deposit
- Some CDs only pay simple interest
- Must be held for a predetermined timeframe
- Limited liquidity (depositors cannot easily access funds in the event of an unforeseen need)
- Relatively low returns (opportunity risk as compared to ETFs and mutual funds)
- Like high-interest savings accounts, the interest earned on CDs is taxable
Money Market Accounts
- Higher minimum balance requirement (usually $1,000-$2,500)
- Inflation risk (inflation growth can outpace interest rate)
- Restricted to six (6) transactions per month per Federal Reserve Regulation D
- Comparatively low interest rates (often in the 1.5-2.5% range)
- Transaction limits (they lack the transaction flexibility of a debit card or checkbook)
Money Market Account vs. CD: Which Is Best For You?
Where you decide to park your money depends on your financial goals and when you need to access your money. If you’re building an emergency fund, CDs are likely not your best option given that they come with early withdrawal penalties. Money markets, on the other hand, are better suited for short-term savings that one might expect to withdraw from multiple times per month.
As compared to money market accounts, a CD is a safe investment option for those who want to save for a down payment on a car or home and know that won’t need to access the funds for a year or longer.
Putting your short-term savings in a CD at 2.5% annual interest may end up losing to inflation by 0.1% in a bad year. Still, it’s a better option than losing to inflation outright if the money had been tucked under your mattress accruing zero interest or kept in a low-interest savings or checking account. The bottom line is that both MMAs and CDs are excellent investment vehicles for stagnant cash in the short-term. Where one should invest merely depends on the liquidity and availability expectations of the investor.
Looking for long term saving advice? Check out our precious metal IRA reviews and our list of the top investment newsletters to stay informed about the latest market developments and how you can insulate your portfolio against market, currency, and inflation risk ahead of your retirement.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Liam Hunt, M.A., is a financial writer covering global markets, monetary policy, retirement savings, and millennial investing. His commentary and analysis have been featured in the New York Post, Reader's Digest, Fox Business, and Forbes.
