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Money market accounts

Money market accounts are basically souped-up savings accounts that sport higher interest rates and higher minimum balances. My credit union, for example, requires me to have at least $10,000 in my money market account, though not all banks have minimums this high. With some money market accounts, you can write a few checks every month, too.

Because money market accounts have higher minimum balances, banks have more leeway to use the funds in your account (see the Note on Savings accounts), so they're able to pay more interest. Other than that, there's not a lot of difference between money market accounts and regular savings accounts. Still, it's important to know the term because it's one you'll hear often.

Certificates of Deposit

Certificates of Deposit (CDs) are time deposits: You give your money to a bank and promise not to touch it for a specific amount of time. A CD is basically a loan that you make to your bank, which can invest the money however it wants during period you agreed to. In general, the longer you let the bank keep your money, the higher the interest rate you get.

Unlike a savings account, once you put money into a CD, the interest rate doesn't change. If you open a 12-month CD at 3.50%, say, and then interest rates drop to 1.00% (as they did in 2008–2009), you still earn 3.50% over the whole year.

The catch is that CDs are less liquid than other accounts, meaning you can't move money in and out of them any ol' time without paying penalties. If you take your money out of a CD before it matures (that is, before the agreed upon amount of time), you'll be docked interest. In some cases, you may even lose part of your principal.

Note

Unlike savings accounts, CDs end—or mature—after a set period. What happens then depends on the arrangements you've made with the bank. Many CDs renew automatically, which may not be what you want. So make sure you know what will happen when yours mature.

Here's a screenshot showing info about an actual CD that I opened recently at ING Direct to set aside money for a trip to France and Italy:

Figure 7-1. The Anatomy of a Certificate of Deposit

This CD started out at $14,000, earns 1.75% interest, and has a term (lifespan) of 12 months. If I decide to redeem this CD early, I'll sacrifice 3 months' interest, regardless of whether I've already earned that interest. In other words, if I had taken my money out of the CD during the second month, the bank would have taken part of my principal because I'd have only earned 2 months' interest at that point.

When my CD matures on November 12, 2010, I'll have $14,244.99—almost $250 more than I started with, which is enough to pay for quite a few nice meals in Europe! That's not a huge return, but your goal with CDs isn't to get rich—it's to earn a decent return in a safe account, and CDs are super safe. This account is a great way for me to earn a little extra money for my trip without worrying about losing money in the stock market. (There's more about risk in Chapter 12.)

Choosing Accounts

As you can see, certain accounts are better for certain situations, so you want to make sure you're using the right tool for each job. When you choose an account, ask yourself:

What do you need the account for? Long-term savings? Business? Personal? Everyday use?

How much will you keep in the account? Remember that some accounts require minimum deposits to get the best interest rate. (To get the top rate with my credit union's money market account, I need to have $50,000 in the account.)

How liquid does the money need to be? If you need quick, easy access to your cash, choose accounts at a local, traditional bank. If you don't mind a small delay in getting to your dinero, an account with an online bank will work fine. And if you can let your money sit for months (or years) at a time, a CD might be your best option.

Do you need easy access to the money? If you need frequent access to your account, make sure to open one with a bank that has ATMs all over