The Downside of Putting All Your Money in Savings Accounts Over CDs

There's really no simpler bank account option for your savings than a savings account. Yes, stashing some cash under your mattress is easier -- but you won't earn any interest, and your money won't be protected. But if you open a savings account, you'll earn interest and have the peace of mind that comes from knowing your money is safe in the event of bank failure (assuming your bank has FDIC insurance).

But savings accounts come with one big pitfall when you compare them to their cousin, the certificate of deposit (CD). Let's take a closer look at the downside of relying exclusively on a savings account -- rather than diversifying by opening a CD, too.

Rates -- fixed or variable?

There are a few big differences between CDs and savings accounts, and the type of interest rate they come with is one of them. Specifically, savings account APYs (annual percentage yields) are variable and subject to change at any point. I opened a high-yield savings account with an online bank in early 2022, and I have received multiple emails from the bank informing me of changes to my rate. Over this period of time, they've all been increases, and this makes sense.

The Federal Reserve addressed sky-high inflation in 2021 and 2022 by increasing the federal funds rate. This doesn't directly inform rates on consumer bank accounts and loans, but they tend to trend in the same direction. The federal funds rate is predicted to fall this year, and when it does, I expect to start getting emails from my bank with the news that my savings account's APY is dropping, too.

But the cool thing about CDs is that when you open one and deposit your cash, you're getting to lock in the CD rate you started with. If you open a 1-year CD with an APY of 5%, you'll earn that 5% over the entire year. If that CD holds $5,000, that equals $250 earned on your money. Over that same year, the rate on your savings account might fall -- but your CD's rate won't.

When is a CD a good idea?

You're probably thinking, "Great! I'll put all my savings into CDs and lock in those high rates." And that may be a great choice. While a CD isn't the perfect solution for all savings situations, it really shines for one in particular.

If you've saved money for a sizeable expense that you'll be incurring in the next few years (such as a down payment on a house purchase, a wedding, or perhaps your child's first year of college), a CD can be a good place to keep it safe and earn a predictable return. The key is to be sure that you really can leave the money alone for the duration of the CD term, as you'll incur early withdrawal penalties if you need to pull your money out sooner.

When is a savings account a better option?

A savings account, on the other hand, is best used for money you'll need soon but that doesn't have a set timeline. This includes your emergency fund -- a CD is a terrible place for that.

Imagine that you have $10,000 in the bank for unplanned expenses, and you need $2,500 of it for a home or car repair. If you have that money in a CD, you'll have to pay a penalty to break your CD term, which means losing part of your interest earnings (or even part of your principal, depending on how long the CD has been open and how long the term is) in the process. But if it's in a savings account (or possibly even a money market account), you can access it without penalty.

A savings account is also a great fit for people who are still actively saving. You generally can't add more money to a CD once it's open, but you can make contributions to a savings account anytime you please.

Now that you know the benefit of CDs over savings accounts (particularly in this high interest rate environment), you might want to take some time to decide if they fit into your savings strategy. If they do, it's a good idea to open one sooner rather than later -- before rates fall.