Stocks or Savings Products?: CDs, HYSAs, and Your Retirement

Lately, my inbox has been filling up with questions about the merits of Certificates of Deposit (CDs) and High-Yield Savings Accounts (HYSAs).

Given the volatility in the stock market and increasing inflationary pressures over the past year, many are wondering whether traditional investment options still hold their appeal. And, since the interest rates of conventional savings accounts usually fall below the inflation rate, they typically cause you to lose money. This has helped both CDs and HYSAs—with current interest rates of 5%—become more eye-catching as investment options for earning more on your cash.

That’s why I wanted to unpack how these savings products work, the nuances that differentiate them, and their place in a broader financial strategy and retirement plan. Your preparation today will serve as the bedrock of your financial security tomorrow. So, let’s dive in!

What Are CDs and HYSAs?

Certificates of Deposit (CDs) and High-Yield Savings Accounts (HYSAs) are specialized financial products that serve as attractive investment options for savers. Offered by a range of financial institutions, including traditional brick-and-mortar banks and online-only banks, these accounts come with the safety net of Federal Deposit Insurance Corporation (FDIC) insurance, which covers up to $250,000 per depositor.

Choosing between these two options depends on several factors, such as your liquidity needs, risk tolerance, and timing. Be aware of potential monthly maintenance fees that could chip away at your earnings. Also, consider that the FDIC insurance that safeguards your deposits up to $250,000 might have particular conditions depending on the account type. Given that interest rates for both CDs and HYSAs are often tied to Federal Reserve policies, the timing of your investment could significantly affect your return, making it crucial to align your choice with your overall financial strategy.

How Do CDs Work?

Certificates of Deposit (CDs) are a type of fixed-income investment that lock in your funds for a predetermined period, ranging from a few months to several years. During this period, your money earns a fixed annual percentage yield (APY), providing a predictable return on your investment. The interest rates on CDs can be influenced by broader economic conditions, including Federal Reserve policies, making timing an essential consideration for maximizing returns.

However, it’s crucial to note that early withdrawals typically incur penalties, which could significantly reduce the overall yield. This is because of the purpose of a CD. Typically, banks offer a higher interest rate on CDs than they do for typical savings accounts. This is because the bank wants to hold on to your money for longer, ensuring they can access funds if needed. Essentially, the bank is paying you to let them keep your money longer.

How Do HYSAs Work?

In contrast, High-Yield Savings Accounts (HYSAs) provide a more flexible saving option that pairs higher interest rates with increased liquidity. These accounts are typically offered by online banks and often require a higher initial deposit but allow for more frequent withdrawals without penalty, making them suitable for those needing quicker access to their funds. Like CDs, HYSAs also express their interest in terms of APY, which can fluctuate based on economic indicators such as Federal Reserve interest rate changes. This liquidity and rate variability make HYSAs a versatile choice for savers, particularly in uncertain economic environments.

How to Open a CD or HYSA

To open a CD or an HYSA, you can approach a financial institution in person or online. The application process generally involves providing valid identification, completing the necessary paperwork, and making an initial deposit. Always be aware of the terms and conditions, particularly those concerning any monthly fees or service charges.

Of course, consulting a financial advisor can help you identify the most suitable option and ensure you’re prepared to open an account.

The Importance of Timing

Timing is crucial when investing in HYSAs and CDs, especially given the influence of Federal Reserve interest rate policies. When the Federal Reserve increases interest rates, these investment vehicles usually offer better APYs. So, if you notice a trend of rising rates, it might be a strategic move to lock in those higher yields for a longer term, particularly in the case of CDs. Conversely, when rates are low or expected to decline, leveraging the flexibility of an HYSA could be advantageous, allowing you to move your funds when rates improve.

Another layer of complexity is added by economic indicators like inflation, which can significantly impact the real return on your investment. For example, a 5% APY may seem attractive, but if inflation rates surge beyond that, the purchasing power of your savings erodes.

For instance, you may want to exhibit some patience in increasing exposure to HYSA products when the economy is in a hyperinflation phase, where there are consistent interest rate increases on a monthly or quarterly basis. In that type of environment, a consumer can risk locking in rates lower than they would have if they had been patient and waited a few weeks before committing to a rate locked in for a period of time.

The Importance of Diversification

While the safety and predictability of CDs and HYSAs make them appealing for many, particularly those nearing retirement age, it’s advisable not to put all your financial eggs in one basket. CDs offer fixed interest rates, which means there’s a ceiling on how much you can earn. An HYSA’s interest rate can fluctuate daily, potentially making it unpredictable.

In addition, if you invest solely in savings products, it’s less likely that your wealth will grow beyond the inflation rate. To truly grow your net worth, you’d need to branch out into other investment options.

Diversifying into other asset classes like stocks or real estate can offer better long-term returns and protect against inflation. The long-term growth of stocks can also help ensure you have enough money to retire rather than rely on the notoriously low income afforded by Social Security.

While investing in the stock market can supercharge your retirement savings through potentially higher returns, this comes with increased volatility and risk. The stock market is especially subject to price swings or market volatility over the short term. While this may seem alarming for those close to retirement, long-term investments have generally proven to recover from temporary declines. So, market volatility shouldn’t deter you entirely. However, you should carefully consider whether these investments fall within your risk tolerance levels and financial goals.

Diversification balances the potential for high, long-term growth against market risk. While one portion of your savings may offer greater growth but be vulnerable to market volatility, the rest can provide stability with lower growth prospects. This approach maximizes long-term earnings without jeopardizing your entire portfolio.

The Bucket Theory

The “Bucket Theory” is a well-regarded method for strategically managing retirement savings. In this model, you organize your assets into different “buckets,” categorized by two fundamental criteria: time horizon and risk tolerance.

The time horizon is essentially the time you expect to hold an investment before you’ll need access to your money. Risk tolerance is your personal comfort level with market volatility and potential fluctuations in your investment’s value.

Using these two criteria—time horizon and risk tolerance—you can make tailored investment decisions. For instance, money you might need in the short term can go into low-risk, readily accessible assets like HYSAs and CDs.

On the other hand, savings you won’t need for many years could be invested in higher-risk but potentially higher-reward assets, such as the stock market. This way, the Bucket Theory helps you diversify your investment portfolio to align optimally with your financial needs and willingness to take on risk.

The Ladder Strategy

The ladder theory provides a strategic approach to investing in CDs that balances risk and reward.

Consider that the interest rates for CDs vary depending on how long the account takes to mature—that is, the time you’ve agreed to let the bank hold on to your funds. The longer the account takes to mature, the higher the interest rate you’ll typically receive.

By creating a “ladder” of accounts with different maturity dates and interest rates, investors can achieve a blended average rate over time, allowing for more consistent returns. As each account matures, you can renew at potentially higher rates, assuming interest rates are on an upward trend.

Like the bucket theory, you can portion your funds into different amounts depending on when you might need to access them in the future. This can help you determine how to build your ladder—how much to invest in each account according to its maturity date.

This laddering strategy not only provides the benefits of diversification but also offers greater liquidity and flexibility. When a rung of your ladder matures, you can reassess the financial landscape and either reinvest in a similar product or pivot based on current economic conditions and interest rates. This way, you’re not locking all your money into one long-term commitment, but rather, have a revolving door of maturities that lets you adapt to the market.

Emergency Funds and HYSAs

When it comes to retirement, high-yield savings accounts might not be the most lucrative plan. However, HYSAs offer an excellent option for creating an emergency fund with surprising benefits for your retirement plan.

Having a separate emergency fund is vital to protecting your tax-advantaged retirement plans, such as a 401(k). It provides a financial cushion, preventing you from dipping into long-term investments during emergencies, such as experiencing an unexpected layoff. This avoids early withdrawal penalties, extra taxes, and missed growth opportunities.

Having an accessible emergency fund can also help prevent you from wracking up large amounts of credit card debt in events such as unexpected car or home repairs.

HYSAs are an optimal choice for building a robust emergency fund. With their elevated APY, your savings grow faster than in a standard savings account, accelerating the time it takes to reach your emergency fund goals. Additionally, the liquidity provided by ATM cards and the security of FDIC insurance help make HYSAs exceptionally practical. This blend of higher growth and easy access allows you to respond to immediate financial needs without jeopardizing your retirement savings.