CDs are time-based deposit accounts from banks, credit unions or other financial institutions. With the exception of variable-rate and no-penalty products, CDs can help balance risk in a portfolio because most require you to keep your money deposited for a set period in exchange for fixed-rate earnings.
CDs can help balance risk in a portfolio because most require you to keep your money deposited for a set period in exchange for fixed-rate earnings. There are some exceptions, such as variable-rate CDs or no-penalty CDs, that have changing rates or don’t require you to leave funds deposited for the CD’s entire term.
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“The pros of investing in a CD include FDIC protection and a guaranteed fixed rate for your cash. Cons include a lack of liquidity and penalties for early withdrawal of your funds.”
– Marguerita Cheng, founder of Blue Ocean Wealth
Early Withdrawal Penalties
Most CDs come with early withdrawal penalties if you take money out of the account before your CD matures, which is when its term ends. That makes CDs best for people who don’t need liquidity for those funds.
“There are certain situations when paying the penalty may make sense,” Cheng said. “For example, covering medical expenses or home repairs when you may end up carrying a balance on your credit card.”
The threat of an early withdrawal penalty could also be useful for some people who are tempted to spend their money if they have easy access to it.
“From a psychological perspective, knowing you would have to pay a penalty to withdraw the money early may make you more disciplined to not touch your money if it’s sitting in a CD vs. other products that do not have a penalty, like your typical savings account,” said Renee Stene, financial advisor and founder of Weddington Advisors.
According to our CD survey, over 83% of Americans with a CD avoid dipping into their principal (the amount of money they invested) before their CD term ends.
Deposit Insurance
If you open a CD with a bank insured by the Federal Deposit Insurance Corp. (FDIC), your deposit is automatically insured at no cost to you for up to $250,000 per depositor, per insured bank and ownership category. This means that if your bank fails, you’ll be covered up to the maximum insurable amount. Credit union CDs, sometimes called share certificates, receive similar protection through insurance from the National Credit Union Administration (NCUA).
Risks
While a CD is an inherently safe fixed-income investment, like any investment, it’s not without some risks.
One of the biggest risks is facing an early withdrawal penalty if you need to access your money before the CD matures. While you can lock in your interest rate for a set amount of time, you won’t be able to use your money for other purposes. If you withdraw funds early, you’ll forgo several months of interest payments as a penalty.
Another risk is missing out on higher interest rates if rates rise during the term of your CD. However, a fixed rate can also work in your favor if rates drop.
Finally, CDs offer lower returns than stocks, index funds and even some bonds. By putting your money in a CD, you’re guaranteeing your interest rate, but you may miss out on higher returns elsewhere.
Some banks offer promotional CD rates alongside their normal fixed CD rates. Promotional CD rates, also called Special CD rates, usually offer competitive APYs and can have unique term lengths such as seven months, nine months or 13 months. These special rates are typically offered for a limited time and are often used to entice new customers.
Here are some promotional CD rates available now:
- Ally Bank: 4.55% APY on a 14-month Select CD through June 19, 2024
- Capital One: 5.10% APY on a 10-month Special CD at 5.05% APY
Once the original term matures, promotional CDs usually renew to the nearest normal fixed-rate APY and term.
The highest CD rates can often be found with smaller banks and credit unions. This is typically because smaller banks are competing for clients against larger banks and credit unions are member-focused, not-for-profit institutions.
How Do I Get the Most Out of My CD?
To maximize your CD earnings, consider the type of CD you need and implement strategies to minimize your potential risk. You may want to use a CD ladder to diversify your maturity dates as interest rates change or a brokered CD to get a broader range of options and potentially higher yields.
Consider Your CD Type
The first way to maximize your CD’s potential is to consider the type you need. Here’s a quick breakdown of how they differ:
Traditional CD | Bump-Up CD | No-Penalty CD |
---|---|---|
Fixed APY for the entire term | Allows you to get a higher rate if the available rate rises during you CD’s term | Doesn’t charge a penalty if you withdraw principal before your CD matures |
Typically offers higher APYs than traditional savings accounts | Provides flexibility in case rates increase before your CD matures | Allows early withdrawal at no cost |
Best for those seeking predictable, guaranteed returns | Best for investors who expect rates to increase | Best for those who may need access to their funds before the CD matures |
Implement a CD Ladder Strategy
Creating a CD ladder involves purchasing CDs with varying maturity dates instead of investing in just one CD.
“By staggering the maturity dates, you can take advantage of higher interest rates without giving up access to your cash for an extended period of time,” Cheng said.
Here’s how it typically works: Instead of putting all of your funds into a single CD, you divide your investment into smaller portions to buy separate CDs with different term lengths, such as six, 12 and 18 months. As each CD matures, you can reinvest the money into a new CD, effectively creating a “ladder” where a CD matures at regular intervals.
“A CD ladder can lower interest-rate risk,” Cheng said. “For example, if you put all your funds in one three-year CD, you may miss out on an increase in interest rates that could occur in the next few years while your cash is tied up.”
Look Into Brokered CDs
Brokered CDs are offered by brokerage firms such as Vanguard, Fidelity or Schwab rather than traditional banks or credit unions. You can often get higher CD interest rates through brokerage firms because they negotiate with multiple banks on behalf of their clients.
Brokered CDs also offer flexibility in terms of initial investment amounts and maturity dates, which could make them attractive options for people who want to diversify their portfolios. But because brokered CDs can be sold on the secondary market, unlike bank CDs, they may lose value.
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Alternatives to CDs
While CDs are a reliable way to earn money on cash investments, there are several alternatives. CDs may offer higher interest rates than traditional savings accounts or money market accounts, and can be less risky than bonds, but their downside is less liquidity. In our recent CD survey, roughly 43% of Americans considered opening a high-yield savings account before opening a CD.
We’ll compare CDs to these other savings and investment options below.
Features | CDs | High-Yield Savings Accounts | Money Market Accounts | Bonds |
---|---|---|---|---|
Type of investments | Time deposit | Savings account | Savings account | Debt security |
APY | Typically fixed | Variable | Variable | Fixed or variable |
Timeline | Fixed term | No fixed term | No fixed term | Fixed term |
Risk | Low | Low | Low to moderate | Moderate to high |
Ease of Access | Limited access until maturity | Immediate access | Immediate access | Varies |
Initial Deposit | Varies | Typically low | Typically low | Varies |
Insured by the FDIC or NCUA | Typically | Typically | Typically | No |
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