high interest savings accounts certificates of deposit

high interest savings accounts certificates of deposit

The difference between money market accounts and certificates of deposit

A money market account (MMA) is a high interest savings account, which can be opened quickly and easily at almost any bank, like any regular savings account. MMA pays higher interest than a regular account, has higher minimum balance requirements, $1,000 to $2,500, and allows three to six withdrawals per month.  

The money deposited in a money market account is invested through the bank or credit union, which collects the return. The interest paid to the account beneficiary is left in the account, but the bank loans that money to other accounts by charging a slightly higher interest for the loan than the interest paid to the account beneficiary. Therefore, the bank makes money by selling money, but it offers the flexibility to the account beneficiary to get the money quickly and easily and without having to pay any sort of penalties. 

A certificate of deposit (CD) is issued by commercial banks and brokerage firms, with specified interest rate and maturity date. Maturity date may be from three months to five years and the funds may not be withdrawn on demand before the maturity date. At the end of the term, which is typically three months up to one year, the deposit is returned with interest.  

Certificates of deposit are relatively safe and account beneficiaries know the return they will receive before maturity date. CDs have higher returns than savings accounts and they protect the beneficiary from the fluctuations of the stock market. On the other hand, the returns are lower than other investments, including money market accounts and the money is tied up until maturity, without the option to get it out without paying a harsh penalty.  

Money market accounts provide greater liquidity than certificates of deposit since the beneficiary may withdraw the money at any time without penalty, but they tend to have lower interest rates than certificates of deposit. On the other hand, a certificate of deposit is purchased for quite long time. Investors know that penalties for early withdrawal are expensive depending on how much money is invested in the CD. Also, by withdrawing the money before maturity means that investors lose as much as 6 months of the interest that the investment has already earned. 

Conclusively, certificates of deposit offer an easy solution for risk-adverse investors, who want only to maintain their capital as they can calculate expected earnings on maturity. However, money market accounts are preferable. The reason is that brokerages firms automatically sweep the uninvested cash into money markets to earn interest between investments. This is ideal for the regular investors, who can use the funds immediately to purchase stocks, bonds, or mutual funds.

Financial Maths Problem!?
Melvin recently inherited $70,000. He invested part of it in a savings account and bought a Certificate of Deposit (CD) with the remainder. He invested $20,000 more in the CD than in the savings account. Both the CD and the savings account pay simple interest, and the interest rate on the CD is 1.5% higher than that on the savings account. At the end of two years, Melvin has accumulated $7,650 in interest. What is the annual interest rate on the savings account?
I get 0.45%, but I dont think that is right

Investment in savings account (x):
$70,000.00 – x = x + $20,000.00
2x = $50,000.00
x = $25,000

Investment in CD:
= $70,000.00 – $25,000.00
= $45,000.00

Annual interest rate in savings account (x):
2($25,000.00x + [{x + 0.015}{$45,000.00}] = $7,650.00
$25,000.00x + $45,000.00x + $675.00 = $3,825.00
$70,000.00x = $3,150.00
x = 0.045 or 4.5%

Answer: 4.5% is the annual interest rate on savings account.

Proof ($7,650.00 is the total accumulated interest on the investments):
= 2 yrs(0.045[$25,000.00] + [{0.045 + 0.015}{$45,000.00}])
= 2 yrs($1,125.00 + 0.06[$45,000.00])
= 2 yrs($1,125.00 + $2,700.00)
= 2 yrs($3,825.00)
= $7,650.00