CDs vs. high-yield savings accounts — where can you earn 5.5% after Fed's rate hike? 'This is time-sensitive.'

By Leslie Albrecht

It's time to lock in high interest rates on cash savings if you can, financial advisers say

Hello and welcome to Financial Face-off, a MarketWatch column where we help you weigh a financial decision. Our columnist will give her verdict. Tell us whether you think she's right in the comments. And please share your suggestions for future Financial Face-off columns by emailing our columnist at lalbrecht@marketwatch.com.

The face-off

Higher interest rates have made it more expensive to carry a balance on your credit card or take out a car loan, but on the flip side, there's an opportunity to earn more interest on cash savings. You can do this by opening a high-yield savings account or buying a certificate of deposit (CD). (This column will focus on those two options; you can read about other cash investments here.)

A high-yield savings account is a bank account that pays better interest than a traditional savings account. Savers can now get annual percentage yields (APYs) above 5% on some high-yield accounts, according to DepositAccounts.com. Online-only banks often offer the best rates on this type of account because they don't have the expense of maintaining physical branches, said Ken Tumin, senior industry analyst at LendingTree and founder of DepositAccounts.com.

A CD is an account in which you deposit money and then keep it there for a certain period, like six months, one year or five years. At the end of that period, you can withdraw the money plus the interest it's earned. At the moment, some CDs are earning as much as 5.5%, according to DepositAccounts.com.

So if you're looking for a place to park cash, does a high-yield savings account or a CD make better sense?

Why it matters

"Not too long ago, it didn't really matter what you did with your cash and now all of the sudden it's extremely important," said Grant Meyer, a certified financial planner and founder of GTS Financial in Bloomington, Minn.

That's because the Federal Reserve embarked on a series of interest rate hikes last year that continued May 3 when it moved its benchmark rate up to a range of 5% -- 5.25%. When rates first started going up in 2022, savers went on the hunt for short-term ways to stash cash. They wanted to avoid getting locked into a particular rate while rates were on a swift upward trajectory.

"Now it's the exact opposite," Meyer said. "You want to consider locking in long-term because, most likely, we're not going to see substantially bigger increases. The rates are around as good as they're going to get. It's definitely worthwhile, while you can, to lock this in. This is time-sensitive. This is something where six months go by, you put it off, you may not be able to get this rate again."

Indeed, the Fed signaled May 3 that it could be done lifting rates for the time being. The Dow Jones Industrial Average , Nasdaq Composite Index and S&P 500 were up Friday on the back of strong jobs figures, but one economist said the data would "dampen market enthusiasm for bets on rate cuts coming soon."

While CDs on average have better rates than high-yield savings accounts, they're not for everyone. Your cash is essentially inaccessible until the CD term ends, and if you need to withdraw money before then, you'll get charged a penalty. With high-yield savings accounts, you can usually take money out at any time, though accounts typically limit the number of withdrawals you can make in a month.

The verdict

High-yield savings account.

My reasons

They may not grow your cash as much as a CD would, but I'm choosing high-yield savings accounts as the winner because Americans need all the help they can get when it comes to building savings. Financial planners generally recommend having a cash emergency fund that could cover three to six months of your expenses. But 32% of households say they wouldn't be able to pay for a $400 unexpected expense like a car repair or a surprise medical bill with cash or its equivalents, according to the Fed's latest report on Americans' economic well-being.

For people who are just starting to build their cash savings, high-yield savings accounts are a quick and easy way to jump in. Many don't charge fees or have minimum balances, so you can start with next to nothing. They're also very liquid, meaning that your cash stays pretty much at your fingertips, though it can sometimes take a few days to transfer money from a high-yield savings account to a checking account, Tumin noted.

But be aware that the term "high-yield savings account" has no formal definition. Banks can slap that label on any account. It's up to you to check the rate that a bank is offering and compare it against other banks and credit unions (look at local or smaller banks too, because they'll sometimes have better rates than big national banks).

Remember that the rates on high-yield savings accounts are variable. That means they can change at any time. Someone deciding between a one-year CD with a 5% rate and a high-yield savings account with a 5% rate might want to go with the high-yield savings account so they could easily get their hands on their money, Tumin said. "The only issue with that is that it might change into a falling rate environment in the next few months, and by the end of year instead of being 5%, that savings account might be paying 2% or 3%, for example. If you had that CD you'd still be getting 5%," he said.

Is my verdict best for you?

On the other hand, rates on CDs appear to be hitting their peak, so this is your chance to lock in those higher-than-usual yields. Once you've established a cash emergency fund, CDs can be one way to boost yields on your cash. Some people even build CD "ladders" to protect their cash.

There's one quirk to be aware of at the moment with CDs. Traditionally, CDs with the longest terms (like five-year ones) have the best rates. But at the moment shorter-term CDs are offering higher rates than longer term ones, a phenomenon known as an "inverted yield curve." This can signal a pending recession, which is relevant here because the Fed would likely lower rates in the event of a recession. That's another reason you may want to act fast to take advantage of higher rates.

"In the end, it's important to understand when you need your money and scan the landscape for the various types of products and their accompanying interest rates before committing to any one of them," said Eric Roberge, a certified financial planner and founder of Beyond Your Hammock.

"CDs and savings accounts can be great for securing money you need in the short term, but they have historically offered interest rates under the average long-term inflation rate," he added. "So, if safety is your goal, they can be great. But, if growth is your goal, then you may want to look at vehicles that expose your money to a little more risk, but also more return in exchange for that increase in risk."

Tell us in the comments which option should win in this Financial Face-off. If you have ideas for future Financial Face-off columns, send me an email at lalbrecht@marketwatch.com.

Also see: 'These high yields are not going to last forever': Fed rate hike may be the last for now. Is it time to say goodbye to 5% on CDs and savings?

-Leslie Albrecht

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05-06-23 1817ET

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