Fixed-Income Investing Tools: Certificates of Deposit (CDs) & Money Market Accounts

By Nick Mango | July 11, 2019

‘Make your money work for you.’ A simple premise, really, and the driving force behind most any growth or fixed-income investing strategy. However, given the combination of increasing market volatility coupled with rising interest rates at the time of this writing, it might be good to examine Certificates of Deposit (CDs) and Money Market Deposit Accounts (MMDAs), both of which are tools that risk-minded investors could use in the ultra-conservative segments of their portfolios.

CDs and money market accounts are pretty straightforward. They are generally FDIC-insured investments and, since both are available through brick-and mortar or even online banks and financial institutions, interested investors could use them to earn investment income without opening a brokerage account.

Now admittedly, both CDs and money market accounts fell out of favor in recent years due to the artificially low interest rate environment. However, once rates are back on the upswing it’s possible that we’ll see a resurgence of sorts continue for the foreseeable future. So, here’s how CDs and money market accounts tend to operate and why one or both could make worthy investment choices for safety-minded investors in a rising-interest-rate environment.

Infographic giving a definition of fixed income investments

Exploring Viable Alternatives to Low-Interest Savings Accounts

Fact: Money simply sitting in a traditional checking or savings account isn’t working very hard for the account holder. In fact, with standard savings accounts paying between, say, 0.03% and 0.09% APR, one could argue that when factoring in inflation, that money is actually losing value each year. With that, quite literally the only benefit to a traditional savings account is ready access to its funds in case they’re needed for some sort of emergency (sudden medical bills, loss of income/employment, etc.).

It’s little surprise, then, that investors (and non-investors) who are understandably tired of earning next to nothing on their savings, are increasingly exploring higher-interest alternatives.

Those may include:

  • High-interest checking and savings accounts
  • CDs
  • Money market accounts
  • Bonds and bond funds
  • Crowdfunding and peer-to-peer (P2P) lending

High-interest Checking and Savings Accounts

A little online research and comparison shopping will confirm that there are higher-interest rate alternatives to standard savings accounts out there. From higher-yield checking accounts at brick-and-mortar banks to better-paying checking and savings accounts at local credit unions and online-only banks, it could be possible to boost yields from next to nothing to as high as a 5% Annual Percentage Yield (APY) by switching to one or more of these savings account alternatives. Transferring funds from a standard savings account at a local bank to a higher-interest savings account at an online-only one could increase APY, in some cases, by as much as twenty times!

Certificates of Deposit (CDs)

Certificates of Deposit (CDs) are generally FDIC-insured promissory notes issued to investors by banks or credit unions. Given their insured nature, funds invested in CDs are widely considered to be as safe as those in savings and checking accounts. The advantage, of course, is that CDs pay higher rates of interest than standard savings and money market accounts, with the best ranging from around 2.7%-3.1% at the time of writing.

Small CDs are those with less than $100,000 in principal. Many banks establish minimum deposits for small CDs; however, these can be as little as $500 - $1000, which is typically low enough so that willing investors aren’t precluded from investing in the products.

Essentially, investors who opt for CDs are sacrificing liquidity (i.e. access to capital) in return for a higher yield. CDs come in varying term lengths, with most ranging from three months all the way up to five years, with longer-term CDs typically paying higher yields than shorter-term ones.

The key drawback with CDs is that capital cannot be withdrawn before maturity or else a penalty is assessed, which would certainly eat into the (modest) returns investors expect from this sort of investment.

CDs could be considered safe and prudent choices for ultra-conservative investors or those who aim to increase yield from the cash component of their portfolio without assuming equity market risk. CDs could also be well-suited for both children and later-stage retirees.

Bottom line: For investors who don’t require access to their capital for a set period, CDs might be viable options for increasing investment income without increasing risk.

Money Market Accounts

Like CDs, money market accounts are interest-bearing, FDIC-insured investments that tend to outpace the minimal returns of traditional savings and checking accounts. However, unlike CDs, money market accounts typically offer readier access to capital through limited withdrawal and check-writing capabilities.

Money market accounts are easily established by dealing directly with a bank or other issuing institution, which will typically invest account deposits in safe, financially stable assets like CDs and various short-term government and corporate bonds.

With the most attractive money market yields ranging from around 2.1% - 2.5% at the time of writing, these accounts, like CDs, appear to be reclaiming their prior role as viable options for putting cash to work and earning modest investment income with potentially very little risk.

Money market account rules and regulations will vary by bank; however, minimum deposits and balances must usually be observed in order to avoid monthly maintenance and service fees which erode investor returns.

Prospective investors should carefully investigate not only yield but also the minimum initial and ongoing balance thresholds before buying this type of investment. Generally speaking, though, for investors with significant cash on the sidelines and who want ultra-low risk and more sizable returns without losing access to their funds for an extended period, money market accounts could be worth investigating.

Impact of Interest Rate Fluctuations on CDs & Money Market Accounts

Typically, CD and money market account yields depend upon factors like economic conditions, prevailing monetary policies, inflation and interest rates. And generally speaking, CD and money market rates tend to rise as interest rates rise, and vice versa.

As an example, in an environment of rising interest rates,  CD and money market account rates become more attractive because the promise of earning 2%-3% on savings may sound like a good deal to risk-averse investors who fear a stock market decline or that a recession might be in the offing.

As with any fixed-income investment, it’s important to monitor changes in the economic and interest rate environment, and act accordingly. For example, investors may opt for shorter-length CDs (a year or less) in a rising-interest-rate environment, in large part so that capital won’t be tied up in a long-range investment in the event that interest rates (and CD yields) tick even higher.

Another strategy might involve splitting up capital in order to ladder multiple CDs of varying lengths (say, one to five years) so as to ensure liquidity in the face of changing interest rates. Using a ladder approach, the investor could opt to re-invest capital from mature CDs into higher-yielding ones (if they are available), or turn to bonds or other fixed-income investments if they happen to be more appealing at the time.

With money market accounts, yield tends to follow a somewhat sliding scale, with rates ticking slowly higher as economic, market and lending conditions dictate. Tighter lending conditions and/or lower interest rates, on the other hand, may lead to lower yields. However, due to the safe and stable nature of money market accounts and other fixed-income investments, sudden and drastic yield changes are neither common nor likely to occur without plenty of early warning signs.

Particularly when interest rates on the rise, fixed-income investments like CDs and money market accounts could play an integral role in helping investors generate safe, steady income with very little potential risk exposure. Further, because these products are widely available through banks and credit unions, it’s rather simple to compare rates, rules and benefits on the internet. Some honest advice, however, might be to favor online-only banks, which save millions in physical operating costs allowing them to offer higher CD and money market account rates for income- and risk-minded investors.

This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions.

The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Past results are not a guaranty of future performance.

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