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Certificate of Deposit: What is a CD?
A certificate of deposit, or CD, is a low-risk investment product offered by banks, credit unions, and brokerages. CDs require you to deposit your money for a specific length of time to earn higher interest rates than a regular savings account. This article will break down everything you need to know about CDs: the best CD rates and investment strategies, CD pros and cons, as well as alternative places to park your cash.
You can find CDs with various rates and terms, but they are commonly as short as three months or as long as five years. In most cases, if you need your money before your term is up, you’ll have to pay a penalty. It varies from bank to bank, but an early withdrawal fee equal to three to six months’ interest is fairly common for a one-year CD. You may also be subject to a restriction period before you can get another CD on those terms. Like a savings account, when you purchase a CD, your deposit is insured by the Federal Deposit Insurance Corp. up to $250,000.
Here’s where a CD can work to your advantage: While your money is in the certificate of deposit, it earns interest. This is denoted as annual percentage yield, or APY. You’ll know the APY before you put your money in the CD. Generally, your CD rate will hinge on how much you’re willing to invest and how long you’re willing to keep your hands off it. Larger amounts and longer terms mean you’ll earn more interest. However, it’s important to note that the interest you earn is considered taxable income.
There are several varieties of certificates of deposit (CDs) to choose from. Be sure to investigate all of them, since a lesser-known CD might be a better fit for your financial situation:
- Traditional CD: This is the simplest, most straightforward certificate of deposit. Put your money in for a fixed time period for a fixed interest rate, such as one year. Don’t touch it for that period, and when your term is up, you’ll get your deposit back plus interest. If you have to dip into your money before your term is up, you could face a penalty.
- Variable-rate CD: Instead of a fixed interest rate, a variable-rate CD offers an interest rate that will adjust in concert with certain rate indexes (this will vary from bank to bank). So you assume a bit more risk here: If rates go up, you could earn more on your deposit than with a traditional CD; if rates go down, you’ll earn less.
- Bump-up CD: A bump-up CD gives you a chance to “bump up” to a new, better interest rate if your bank raises rates on CDs similar to yours during a certain time frame. You can usually only do this once, or possibly twice if your CD has a longer term.
- Liquid/no-penalty CD: If you’re commitment-phobic, a liquid or no-penalty CD lets you take your cash, plus interest earned, and run before your term is up. However, you’ll probably earn a lower interest rate for this convenience.
- Callable CD: Get a callable CD and your bank will pay you a higher interest rate, but the catch is they can “recall” it before the term is over — typically when rates have fallen far below the one you nabbed when you got the CD. You’ll get your deposit back and any interest earned until that point.
- Jumbo CD: A jumbo CD is basically just a certificate of deposit that requires a large minimum deposit, like $100,000, and pays a higher interest rate in return.
- IRA CD: An IRA CD is simply a CD that you invest in as part of an individual retirement account, which is a tax-advantaged account where you stash your money. The IRA can have several kinds of assets — not just CDs. Though very low-risk, CDs probably aren’t the best way to grow your money in a retirement account, unless you’re very near or in retirement already.
CD Pros and Cons
Now that you know some of the basics, you are probably wondering whether a CD is for you. Here are some of the advantages and disadvantages of CDs to help you decide:
- Low risk: If you want to take baby steps into the world of investing, a CD could be a good first step. You’re guaranteed to get your deposit back, plus the specified APY, which you know in advance. Even better, you have zero risk of losing a single cent of your investment.
- Ease of use: You can easily open a certificate of deposit yourself and without the assistance of a financial adviser. Additionally, with most CDs, you can “set it and forget it”: That is, once you’ve opened your CD and put your money in, you don’t have to do much else.
- Higher interest rates (at most traditional banks): Traditionally, CD rates are higher than savings account rates to entice you to part with your money for the specified term. This is still mostly true when it comes to brick-and-mortar banks and credit unions. However, it might not be the case when you factor in some high-yield savings accounts online, which I’ll return to later in this article.
- Low liquidity: Since you’ll face a penalty fee if you need to take money out of your CD before your term is up, it’s not the best place to put any money that you need ready access to, such as an emergency fund.
- Lower interest rates (compared to other investments): While some CD rates may be higher than certain savings account rates, you’re not going to earn anything approaching what you could earn with more aggressive, higher-risk investments.
Five Steps to Get the Most Out of a Certificate of Deposit
- Learn about the different types of CDs available today.
- Compare banks offering CDs to see how their rates stack up for different terms.
- Compare CD rates from online banks.
- Consider high interest savings accounts, money market accounts, and other alternatives to CDs.
- Shop around until you find the best interest rate on a CD for your ideal term.
What Are the Best CD Rates Today?
CDs aren’t known for their high yields, but for the security they offer instead. As is par for the course in the world of investing, the lower your risk, the lower your return. According to the FDIC, one-year CDs earned an average of 0.66% APY as of April 2019, marking a sharp increase over the past five years. In contrast, average annual percentage yields (APY) for money market accounts averaged 0.19% APY and savings accounts earned an average of 0.08% APY.
Of course, you can do better than the national average by doing a little research — even without a massive opening deposit. Check out our rates pages for the best deals of the day, and expect fluctuations just like in the stock market. As of April 2019, offers 2.36% APY on one-year CDs with no minimum deposit. Rates will increase at some banks based on a higher minimum deposit or a longer term. For example, if you can keep your hands off your money for three years, Discover Bank, Member FDIC is offering .55% APY as of November 2020, while Capital One offers 3.05% APY with no minimum deposit on a five-year CD.
How Can I Maximize My CD Interest Rates?
While even the best CD rates can’t compete with long-term stock-market gains, there are a few investment strategies you can use to boost your CD returns and allow you to access your money more often in a penalty-free way.
Laddering, the most popular CD investing strategy, helps you enjoy the higher interest rates of a certificate of deposit while maintaining access to at least some of your cash — making a CD ladder a candidate for part of your emergency fund.
Here’s how to ladder CDs: You divide your investment into equal portions, and put each portion into a CD with a different term. Once the CD with the shortest term matures, you reinvest it in a longer-term, higher-rate CD. You keep doing that once each CD matures so that eventually every CD will have a higher rate, with one maturing every year.
Let’s look at an example: You have $10,000 in savings to invest. You divide it into five $2,000 chunks, and put each $2,000 into CDs with terms of one, two, three, four, and five years. Once your one-year CD matures, you take your deposit and interest and put it in a five-year CD. You do the same once the two-year CD matures, and so on. After five years, all of your CDs have five-year terms and a more favorable interest rate, but you’ll still be able to access part of your cash, since one will mature every year.
You can also stagger shorter-term CDs to ensure you have a chunk of your savings maturing monthly. For example, say you start with $12,000. In month 1, put $1,000 into a six-month CD and another $1,000 into a 12-month CD. Do the same thing for the next five months, and then you’ll have a $1,000 CD maturing monthly, which you renew into 12-month CDs unless you need the money that month.
CD Barbells and Bullets
CD barbells and bullets require a bit more awareness of the interest-rate climate to be as effective as possible.
With a CD barbell, you invest in a short-term and a long-term CD at the same time. Once the short-term CD matures, you have the flexibility of deciding what to do with the money — for instance, hold on to it, or reinvest it in another short- or long-term CD, depending on interest rate trends — while knowing the other portion of your money is earning a higher interest rate in the longer-term CD.
With a CD bullet, you aim to have several different CDs mature at once. This is best if you’re betting interest rates will rise, or you’re saving for a particular purpose and won’t need the money until after the CDs mature. For example, maybe you want to invest some of your money in a five-year CD now, and then in two years, some in a three-year CD, and then in two more years, a couple of one-year CDs. All of these CDs mature at the same time, but you still had access to at least a portion of your money until the last year.
Alternatives to CDs
If you’re not quite sold on CDs, there are some other low-risk alternatives that might be a better fit — some more liquid than CDs, and some less so.
High-Yield Savings Accounts
A high-yield savings account offers a beefier interest rate than the paltry national savings account average, which was 0.10% as of April. Online, you can find high-yield savings accounts offering up to 2.0% APY or more. That beats the national average for a one-year CD, 0.66% APY, by a mile.
Perhaps the bigger advantage with high-yield savings accounts, however, is that you’ll still be able to access your money when you need it. That makes these accounts a better pick for any money you need to be able to withdraw quickly and penalty-free, such as an emergency fund. These savings accounts do have federal limits to the number of withdrawals you can take in a month. You can lose the account if you take money out more than six times in a calendar month; however, there is typically no limit to the amount you can take out at one time.
Of course, if you opt for a high-yield CD online or open one with a higher balance or longer term, a CD can still beat these accounts when it comes to APY. Savings accounts also offer a bit less certainty when it comes to interest since the rate can fluctuate with the market — good or bad. On the other hand, a traditional CD will have a fixed rate for its entire term.
Money Market Accounts
For bank customers, a money market account, or MMA, is very similar to a high-yield savings account. Whichever way you go, you’ll have the same access to your cash. The major difference is on the bank’s end — it can put your balance in low-risk investments such as CDs and bonds instead of simply using it to make loans.
You may need a larger opening deposit for an MMA than a savings account ($1,000 is common), but this depends on the bank. Interest rates will be higher for MMAs than savings accounts at brick-and-mortar banks, but the difference compared with high-yield savings accounts online is negligible.
Bottom line: Both an MMA and a high-yield savings account, particularly online, can provide a more liquid alternative to a CD without a huge interest-rate hit. And they’re still FDIC-insured, unlike more sophisticated investments.
U.S. Savings Bonds
Series I U.S. savings bonds are an interesting alternative to longer-term CDs. You can buy them directly from the government in any amount from $25 up to $10,000. They are slightly less liquid than CDs because you aren’t allowed to redeem them for at least a year after purchase, and even then you will pay a penalty of three months’ interest if you haven’t had the bond for at least five years. They don’t fully mature for 30 years. But they do have some tax benefits: You don’t have to pay state or local taxes on this investment.
From November 2018 through April 2019, these bonds are earning a fixed rate of 0.50% interest. Before you write off savings bonds, consider this: The government also sets an inflation rate for bonds. This rate, which will change every six months, ensures that you never lose money due to inflation. Even in periods of deflation, the bond’s composite rate (the combined fixed interest rate and inflation rate) is never allowed to go below 0.0%.
For now, CDs may be the better long-term bet interest-wise. But if inflation starts to rise sharply, that might not always be the case.
On the surface, a Series EE savings bond is a lot like Series I: You get the same tax benefits and can buy them in the same values. They mature in the same time frame, you can’t redeem them for at least a year, and you pay the same interest penalty during the first five years.
Unlike Series I bonds, EE bonds are currently paying a fixed interest rate of 0.10%. Still nothing to write home about, but: If you can hold on to your Series EE bond for two decades, the U.S. Treasury guarantees it will double in value after 20 years — so if you put away $5,000, after 20 years, suddenly you’ll have $10,000. That’s ultimately an APY of around 5% — a lot juicier than 0.10%.
Of course, only you can decide whether you’re willing to part with your money for that long. You could always buy a five-year certificate of deposit, then reinvest the money depending on what interest rates are doing. In general, a period of low interest rates (like the present) makes EE bonds a better deal — but they’re unlikely to stay low for two decades.
In the past, savings bonds were advertised as a low-cost way to give a new child a nest egg; they were given at birth and expected to mature about the time that the child finished college. This can still be a thoughtful way to invest in a child’s future and ensure that the money will be ready at the point when that child is reaching independence.
Treasury Bills, Bonds, and Notes
You can buy a variety of securities directly from the government, and since Uncle Sam backs these investments, your risk is negligible. Like the savings bonds above, you’ll also pay no state or local taxes on the interest. There’s no penalty for selling before they mature, though commissions may apply if you use a broker.
- Treasury bills are for the short term — they range from four weeks to one year. You buy them in multiples of $100, but at a discount. When the term is over, you receive face value. One-year Treasury bills have netted roughly 2.4% to 2.6% in April 2019 — this is in line with high-yield savings accounts.
- Treasury notes can be bought for two-, three-, five-, seven-, and 10-year terms, also in multiples of $100. Interest is paid semi-annually. Two-year notes have recently yielded roughly 2.5%. Current conditions are similar across the lending spectrum, though this is not the case in all economic climates. As of the same reporting period, 10-year notes have yielded 2.7%.
- Treasury bonds are longer-term investments that mature in 30 years. They are also sold in multiples of $100 with interest paid semi-annually. Recently, yields have hovered just under 3%, beating five-year CDs — but you’ll need to lock your money up for a lot longer.
Overall, CDs, high yield savings, and Treasury bills all offer similar rates with different liquidity at the moment. This can vary significantly at different times, based on economic conditions. Because of this, it’s always a good idea to consider both rates and the ability to pull your money out if issues arise.