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Many people wonder, "How can I make my money work for me without taking on too much risk?" Whether you're building up your emergency fund, saving for a...
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Many people wonder, "How can I make my money work for me without taking on too much risk?" Whether you're building up your emergency fund, saving for a big vacation that you have coming up, or looking just to grow your money without rather than the roller coaster of the stock market, you've probably heard of a high yield savings account, a CD or certification deposit, and a bond.
But what's the difference between this? Which one is better for me? Hi, my name is Prince Chenou. I work at a big finance institution and I create these videos to talk about all things personal finance to make it simple, practical, and accessible for everyday people just like yourself. So, let's break it down.
What is a high yield savings account? You can think of it like a traditional savings account, but on steroids. It offers much higher interest rates than what you would get from your local bank. While your traditional savings account might offer 01%. A high yield savings account can offer anywhere from three to 5% interest rates or APY.
This of course really just depends on the bank or the current interest rate environment at the time. These accounts are usually offered by online banks or credit units with lower overhead costs that allows them to pass along the higher rates to the customers. Plus, your money is typically FDIC insured up to 20 225 $250,000.
So now why would someone use a higher savings account in the first place? There are many reasons, but let's focus on three main reasons for today. One, ease of access to your money. This is ideal when you're saving for an emergency fund, short-term saving goals, or just parking cash in between investments. Unlike a CD or a bond, you're not locking your money away, making it convenient for any unexpected expenses that come up.
It's flexible without sacrificing safety. Two, low risk. As I mentioned earlier, many institutions are FDIC secured up to $250,000 per deposit, per account, per account type. This means that you can have an individual account in your name, a joint account with your spouse, or even a custody account with your kid. And each account will be insured separately up to that $250,000.
All this means that your money is protected even if the bank that you have your money is is at goes under. Three, higher rates. Traditional banks offer like I said 01% or less and that's essentially nothing compared to inflation. High yield savings account on the other hand offer 3 to 5% in interest rate.
So while it's not investment level growth, it's still a great way to make your money work for you passively especially when you compare it to letting it just sit idly in your regular savings account. While this is great, I also want to talk about some of the drawbacks of a higher savings account.
First is the interest rate can fluctuate. One of the biggest things to understand about a higher savings account is that the interest rate is not locked in. Rates are tied closer to the federal funds rate which is set by the Federal Reserve and can change depending on the economic conditions. So if the Fed lowers the rates, your higher savings account interest rate could drop significantly, sometimes without even much of a notice.
The good news is that your money remains safe and secure, but the bad news is you're not lo you're no longer earning as much as you were before. In contrast, something like a CD offers a fixed rate for a set period of time, so you're protected from the rate drops during that time.
Another one, the withdrawal limits. Another thing to keep in mind, most higher savings account would come with the withdrawal limit. While the f federal regulations have eased up on the recent years, many banks still limit to six withdrawals per month for your savings account. Go beyond that, you might face fees, account freezes, or have account reverted to a checking account.
Also, since higher savings account are often hosted by online banks, it can take one to three business days to transfer the money to your checkings account. So, now moving forward, I want to talk about what is what are CDs or certification of deposits. So let's dive into it. A CD is a solution offered by banks and credit unions where you agree to leave your money untouched for a certain amount of time and that's usually called the term and in exchange they give you a guaranteed interest rate.
The key benefit is the stability. Unlike high yield savings account that have interest rate that changes, CDs are locked in that rate so you know exactly how much you are earn. So, common CD terms include three months, 6 months, or a year, but you can go as short as seven days, or as long as 5 years or more.
CDs are great middle grounds for people who want a better return than the savings account, but also ready to aren't ready to invest in the market. Here are some trade-offs, though. If you withdraw it early, you're likely to pay penalties, sometimes negating the gains you would have made from the CD. So, why would you want to use a CD?
Here's are some common reasons people choose to put the money in the CD. One, you have extra cash and you don't want need it right away or you have money just sitting you need to that you won't need for the next 6 months to a year. Putting into a CD allows you to earn more interest in the savings account without worrying about daily market changes.
Two, you want a guaranteed return without a with a CD and there's no guesses. The bank tells you up front the term, the interest rate, and exactly how much money you will get when at the end of it. That predictability gives a lot of people peace of mind, especially if they're risk averse.
Three, you're okay with less flexibility. If you're someone who tends to dip into your savings more than you like, a CD can act as a force discipline. You can't touch the money without a penalty penalty. So it stays put until you're ready that until you really need it. So for example, let's say that you have a honeymoon or vacation that you have for next year.
If that's 12 months away, putting that money into a one-year CD and help you earn more interest than keep it in your savings account with virtual zero risk as long as you don't need to access it early. So what are some of the drawbacks of a CD? Even though a CD can be very useful, there's some drawbacks that I do want to still mention.
One, like I said earlier on about the penalties associated with early withdrawals. If you break the term early, then you can pay a penalty for that. That penalty might cancel out the interest that you would have earned or even cut into the original deposit. So, you should only commit money that you're confident you won't need for the duration of the CD.
Two, interest rate risk. If you lock in a CD at 4% today and then rates jump to five to 6% the next month, your money is now stuck at a lower rate, you miss out on those high earnings unless you're willing to break the CD and again you're likely to pay penalties on that.
So now moving forward to bonds. What is a bond? So a bond is a sign a slightly more advanced but very useful saving and investment option. A bond is essentially a loan that you give to a company, government or municipality. In exchange they give you or they pay agree to pay you an interest usually in the form of semiannual coupon payments on the return of and then return of the full amount called the principal at the end of the bond term.
So there's different types of bonds out there. There's three main ones. First ones are treasury bonds. These are issued by the US government and these are considered the safest types of bonds out there because it's backed by the full faith and credit of the United States. They tend to offer lower interest rates, but there are virtually no risk of default.
Two, municipal bonds or mun bonds. They're issued by states, counties, or cities. And these bonds help to fund public projects like roads and schools. One big advantage is that many of them are taxfree at the federal level and sometimes at the state level, too, depending on where you live. Three, corporate bonds. These are issued by companies like Apple, Amazon, or even smaller companies.
They usually offer higher interest rates than the government bonds because there's more risk associated with it. The higher the risk of the company not paying back, the more that they'll pay you to take that risk. So why would somebody want to use a bond in the first place? Let's break it down. One, predictable income.
Bond pay consistent interest usually every 6 months. They make them a great option for people who want a stable cash flow like a retiree or conservative investor. Two, portfolio diversification. Bond tends to behave differently than stocks. So when your stock market may go down, bonds may stay flat or even go up. Adding bonds in your investment portfolio helps balance out volatility and managing risk.
Three, tax advantage. Municipal bonds are often exempt from federal income taxes and in some states or cases, state taxes, too. If you're a high tax bracket, these can be a smart way to reduce your overall tax burden while still earning a steady return. But here's some of the drawbacks associated with bonds. While bonds are generally safer than stocks, they often they don't go without risk.
So for one, interest rates are an issue. Bonds and interest rate move in opposite direction. So for example, let's say that you buy a bond paying 4%. Then a new bond start offering 6%. Your bond now is less attractive attractive in the market. So if you try to sell it before the maturity, you have to sell it at a loss.
Two, less liquidity. Compared to solutions that we talked about like savings account or a CD, bonds aren't very liquid. You can't just pull your money out whenever you want to. You have to sell the bond on the secondary market, which may take time and you might not get full value for it. So let's think about it.
When does it make sense to use either one of these options, higher savings account, CDs, or bond? So, here's a quick breakdown based on your needs. If you need daily access to your funds, then the high yield savings account would make sense. If you're saving for a 6 to 12 month goal, a CD would be appropriate.
If you want predictable income over several years, a bond would make sense. If you're building up an emergency fund, 3 to 6 months of expenses, a high yield savings account. If you're looking for a long-term low-risk investment, a bond would be your option. If you want passive savings with no market stress, a CD or a high yield savings account would make sense.
But here's the best part, though. You don't just have to choose one. You can layer these tools together to build a strategy that works for your overall goals. You can use a high yield savings account for an emergency fund. Open up a CD for a vacation that you are planning in 3 months and then buy a bond or a bond fund for long-term income and stability in your portfolio.
These products complement each other. It's not an eitheror situation. It's about choosing what fits best within your financial plan. So remember, these are all tools in your toolbox. Each one has its own purpose, strength, and trade-off. The key is understanding your timeline, your comfort with risk, and your financial goals. Once you know that, you'll know exactly which tool to reach for.
And if this video helped you, please don't forget to like, comment, and subscribe, and put down below any thoughts or anything that you have. Thank you so much, and have a blessed day.
This video is for general educational purposes only and is not personalized investment, tax, or legal advice. Every situation is different. Talk with a qualified professional about your circumstances before acting. PLC Wealth Partners is a registered investment adviser. See our disclosures.
