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Savings Account, 6-month CD or 12-month CD?


If you have some money that you won't need for at least a year, where's the best place to put it? Would a high-yield savings account like at EmigrantDirect be better than a high-rate 6-month CD? Or a 12-month CD? I've tried to come up with some simple rules of thumb that may help you decide.

The most important question is your need for the money. Is it money that you almost certainly can live without for at least one year? If there's a good chance that you'll need the money sometime within the next year, a high-rate savings account would probably be the best choice.

If you don't care about liquidity over the next year, the next big question is how will interest rates change. This is where it gets tough since no one can predict future rates. It seems likely that the Fed will raise rates at least 3 more times over the next few months. However, in my opinion, 2006 probably won't see as many rate hikes as 2005.

Savings Account or CD?

One simple method to decide between a savings account and a CD is to make an estimate of what the savings account rate will be when the CD matures. Then take the average of the initial and ending savings account rate and compare that average to the current rate of the CD. If the average is better, than the savings account is the better deal.

For example, suppose you're considering leaving your money in EmigrantDirect's savings account which is currently paying 4% vs. a 1-year 4.75% CD at GMAC Bank. Let's assume that one year from now EmigrantDirect's savings account will be earning 5%. This seems like a reasonable assumption since Emigrant's savings account started this year at 3% (see rate chart). Over the next year, your average rate of return would be about 4.5% which is 0.25% less than the 1-year CD option.

6-month vs. 12-month CDs?

Would a 4.45% 6-month CD be better than a 4.75% 12-month CD? For this comparison, estimate the 6-month CD rate 6 months from now. Take the average of that rate and the current rate. If the current 1-year CD rate is higher than this estimated average rate, the 1-year CD would be better.

About 6 months ago, GMAC Bank was offering 6-month and 12-month CDs at 3.65% and 3.90% APY. Currently, GMAC's 6-month and 12-month CDs earn 4.45% and 4.75% APY. If you had purchased a 6-month CD back then and renewed it today, the one year average return would be about 4.05%. This is about 0.15% higher than what you would have received in a 1-year 3.90% CD back then.

At GMAC Bank, a 6-month CD rate increased from 3.65% to 4.45% in 6 months. If this same increase occurs in the next 6 months, you would expect 6-month CDs with rates of 5.25% around June of next year. The average of 4.45% and 5.25% is 4.85%. So a 1-year CD would require a rate of at least 4.85% today to be better than a 4.45% 6-month CD assuming that rates increase the same as they did this year.