Short Term CD vs. Online Savings Account

In the discussion on my post about the PayPal money market fund, Pakdamek posted a question about short-term CD options and asked for assistance.

My recommendation was to review the current high yield rates for 6-month CDs at Bank Rate, but that Pakdamek might also want to consider an online savings account.

6-Month CD
Looking at the current rates across the country, you will see that the high end for the 6-month CD is right around 5.40-5.45% APY which is higher than many of the standard rates with the online savings accounts. However, the current national average for a 6-month CD is lower, around 4.60% APY.

Looking a little further, many of the CDs offering the higher rates have a higher minimum deposit, often in the range of $1000-$10,000. Depending on your scenario, this may be in the ballpark for you but you might have a smaller amount that you are looking to set aside. If you don’t meet the minimum deposit, you will not be eligible for the high yield CD at many of these institutions.

If you do meet the minimums and find a competitive rate, one of the potential rewards with a short-term CD is that it locks in your interest rate for the defined period of time. Obviously if the rates decrease during that time, this will work to your advantage but it can work against you just as easy if the rates actually increase.

Online Savings Accounts
The key players in the online savings accounts (INGDirect, HSBCdirect, EmigrantDirect) all offer accounts that are quite competitive with the 6-month CD. In some cases, the rates with the online savings account beat those of the short-term CD. For instance, HSBCdirect has been running a promotion that all new deposits earn 6.00% APY until April 30th.

One of the key advantages to an online savings account is the lack of a minimum deposit. This opens the door to virtually everyone as you do not need $10,000 or more to take advantage of the high rates. In addition, you have the flexibility to add or remove funds over time as your needs change. With the short-term CD, you are locked in with that CD until maturation and you will face penalties if you need to cash out the CD before the expiration.

Contrary to the CD, an online savings account is open to rate fluctuations based on the current market conditions. If this is a concern to you then you might be more comfortable with the short-term CD. However, rates have been fairly consistent for some time now and this has been a benefit to the online savings accounts.

Other Options
Other options for short-term savings would include vehicles such as a money market account or t-bills, which can be purchased directly at TreasuryDirect.gov without much hassle. The rates here are quite similar to the online savings accounts and offer similar advantages versus the short-term CD.

The Winner Is…
For my money, the winner is the online savings accounts. As I mentioned, I’ve been taking advantage of the 6.00% APY promotion being run by HSBCdirect and also maintain an account with INGDirect. Once the promotional period at HSBCdirect expires, my account will revert back to the standard 5.05% APY and that is still better than many short-term CDs.

In my opinion, the short-term CDs just do not have enough advantage in the current market to warrant using them over these other options. With the CD, you lose the liquidity of your money and the spread in interest rate (if one even exists) is not great enough to justify the potential drawbacks to a CD.

If you haven’t done so already, I highly recommend that you take a few minutes to explore an online savings account today. You can open an account with a $1 deposit and then experiment with the site to determine if it will work for you. For the best rates, I would recommend either HSBCdirect or EmigrantDirect. For the best user experience, I would recommend INGDirect.

As a note, you can receive a $25 account bonus with an initial deposit of $250 at INGDirect if you are referred by an existing account holder. If you’re interested, please leave a comment on this thread or contact me to ask for a referral (disclosure: I will receive $10 for each referral).