Certificates of deposit (CDs) and money market funds are considered to be safe investment vehicles, although there are differences in the amount of security they provide, and in the way their rate of return can be determined. Choosing between them should be based on your needs regarding the interest rates you wish to receive, as well as liquidity you need in your money.

CDs Vs. Money Market Funds

A certificate of deposit is a bank account with a fixed term of investment, measured in months or years. Once you have made the investment, you will not be able to cash in the CD before the end of its maturity period without incurring significant penalties, which negates the point of purchasing the CD in the first place. In return, the rate of interest on a CD is locked in, and cannot change for the lifetime of the investment. Money market funds, on the other hand, act more like bank accounts. You are able to make deposits and withdrawals from the account, although there may be limitations on the number of transactions you can make each month. Money market rates are variable and can change over time; typically, they are lower than the rates offered for equivalently sized investments in CDs. Under legislation passed in 2009, CDs are insured by the Federal Deposit Insurance Corporation for up to $250,000 through the end of 2013. After Jan. 1, 2014, this insurance ceiling will drop to $100,000 except for individual retirement accounts and certain other retirement investments. Check with your bank to determine current insurance coverage after 2014. Money market funds, on the other hand, are not insured, but are generally considered safe except in extreme (and rare) circumstances.

Calculating Return

The bank will generally list two different interest rates: the annual percentage rate (APR), and the annual percentage yield (APY). Your yield is the actual amount which you can expect the investment to pay, and will be slightly higher than the annual percentage rate, because your interest is compounded. Every month, you earn interest on your original investment (called the principal), and the interest on the interest earned to date. Compounded interest is the reason why it is good to invest for the long term, as it exponentially increases your investment income.

Deciding Between CDs And Money Markets

You can directly compare the annual percentage yield of a CD and a money market fund to determine which one is the better investment. Lean toward a money market fund if there is any chance you'll need the money earlier than the term of the CD; likewise, a CD is probably the better investment if you know you can lock up the investment for the entire period.

Source:

AARP: Getting a Decent Return on Safe Investments

Get Rich Slowly: How to Find the Right CD or Money Market Account

FDIC Extends Insurance Limit Through 2013