Money Market vs. CD: Which Should I Choose?

For people who want to generate some interest income from their cash savings, two popular choices are money markets and certificates of deposit (CDs). When you buy a certificate of deposit, you are essentially lending money to a bank in exchange for interest payments.

Money market investments offer a similar stream of passive income, but they come in two types: accounts and funds. These money market products offer more flexibility, while CDs guarantee an interest rate throughout the lifetime of the CD.

Here's an overview of how CDs compare to money markets and how to decide which is right for you.

What's the Difference Between CDs and Money Markets?

FDIC Insurance

Certificates of deposit are typically FDIC-insured. As long as the CD issuer is FDIC-insured, the bank's promise to return the money is covered up to the $250,000 FDIC limit, just like funds in your savings or checking account. Even if the bank collapses, the owner of the CD will still get their money returned.

Money market accounts are similar to savings accounts in that they're typically FDIC-insured as long as the institution offering the account is FDIC-insured. However, money market funds—which essentially operate like a mutual fund containing relatively safe bonds—are not.

Timing

CDs are timed deposits. That means there's a specific timeline involved with the product. You know the exact day you will get your money back before you put your money into the CD. Attempting to withdraw your money before that date may trigger penalty fees.

Common timelines for CDs range from roughly three months to several years. Depending on the institution issuing the CD, you may receive higher interest rates for picking a CD with a longer timeline. CDs also differ in the way they distribute interest income—it may be monthly, quarterly, annually, or all at once upon the CD's maturity.

Money markets—both accounts and funds—function more like a standard bank account or mutual fund. For the most part, you can deposit and withdraw money as you see fit. There may be limitations on how many times you withdraw in a given timeframe, but in general, there is much more flexibility with money markets.

Interest Rate

Similar to the pre-determined time frame of a CD, the interest rate remains steady, as well. You know the interest rate you will receive throughout the time you own the CD before you acquire it.

Money markets, on the other hand, have variable rates that change with market forces. Your interest rate could go up or down, it all depends on the broader interest rate environment.

The Pros and Cons of Money Market Accounts

Money market accounts are similar to savings accounts, but they can offer higher interest rates. Some also let you make payments directly from your money market account with checks, a debit card, or online bill pay. Savings accounts typically do not accommodate payments.

The Pros and Cons of CDs

CDs are time deposits that pay relatively high interest rates. You commit to leaving your funds with the bank for three months to several years, and in return, banks reward you with a higher APY. However, if you withdraw funds early (before your CD’s term ends), you may have to pay an early-withdrawal penalty.

CDs typically offer a fixed rate for a specified length of time. For example, if you get a two-year CD, the rate is guaranteed for that entire term. If rates fall after you buy a CD, you benefit. But if rates rise, you generally don’t get a higher rate.

Some CDs are more flexible than traditional CDs. For example, liquid CDs allow you to withdraw funds before the term ends without paying early-withdrawal penalties. Other CDs enable you to “bump up” your rate if interest rates rise before your CD matures.

Which Is Right for You?

CDs and money markets are different products with different advantages. Knowing what's most important to you can help you choose between them.

CDs Are Best for Planning

CDs come with specific terms that are FDIC-insured. Before you buy a CD, you can calculate your expected earnings before investing because you know your interest rate and tax bracket. This isn't possible with money market accounts or money market funds because those interest rates fluctuate over time.

Also, a money market account's interest rate might vary by balance, which means it could change as you deposit more or withdraw funds. This makes CDs an ideal solution for individuals who want to focus more on capital preservation than growth.

Money Markets Are Best for Flexibility

Although CDs typically have higher interest rates than money markets, your money is locked up for several months or years. Opting for a longer maturity involves a certain degree of opportunity cost risk; the longer you lock away your money, the more likely it is that better opportunities for your money will arise.

Money markets are very liquid, and you can withdraw your funds at any time with no penalties (as long as you aren't frequently making withdrawals). Unless there is a liquidity crisis or fund-specific catastrophe, the odds are good that your money markets are going to be available to you with much less hassle than a CD.

Also, while the fluctuating interest rates of money markets could be a negative for many investors, it may not be a negative for all investors. High-income investors or investors with significant amounts of capital may prefer money market accounts since the interest rates usually increase as the balance grows.

A Best-of-Both-Worlds Option

You don't need to choose between the two. Using both CDs and money markets can be a great way to diversify your savings.

For example, let's say you have $2,000 cash. You know you want to use $1,000 for birthday presents on your child's birthday, and you don't know how you want to spend the other $1,000. In that case, you could put $1,000 in a CD that matures just before your child's birthday, and you could put the other $1,000 in a money market until you think of something to do with it.

Alternatively, you may be concerned with getting the absolute best interest rate possible, and you believe rates will increase in the coming months, but you aren't sure. In that case, you could put most of your money in money markets (to capture any rate hikes) while saving a bit of money for a CD as a hedge (in case you're wrong and interest rates fall in the coming months).

The Bottom Line

Both CDs and money markets are useful for those who want to earn passive income without diving into securities like tax-free municipal bonds or corporate bonds. For those who need easier access to their money, a money market may be a better option. For those who don't mind locking away their savings for an extended period, CDs are often the better portfolio selection. As with any financial issue, an investment advisor can best help decide what makes sense for your personal situation.

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