CD rates are higher, but should you put your money into it? Keep in mind your goals.
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2022 wasn’t kind to our wallets. But amid rising prices (i.e., inflation), there is at least one advantage: savings account rates have increased, including on certificates of deposit.
Some CDs have returns as high as 3% right now, but like any bank account, they don’t work for every financial situation. Let’s see if CDs make sense for you.
Quick Definition: CDs contain money, not music
If you came to this article thinking of a CD as much as a music CD, I apologize – but good luck with your old music collection.
In banks, CD stands for Certificate of Deposit, a type of savings account with a fixed term and a fixed interest rate. You can add money, wait for the CD to expire – usually three months to five years – and get your money back with interest.
The main places to open CDs are banks and credit unions, which are their non-profit counterpart banks. Credit unions tend to call CDs “Certificates of Participation.” Brokers also offer CDs, but the process is more complicated and requires an investment account.
more: Surprise! CDs are back in vogue with Treasurys and I-bonds as a safe haven for your money
CDs: The Good, the Bad and the Punishment
Here’s the biggest reason to consider CDs: They can offer the highest guaranteed returns for a bank account. Current CD rates are among the highest in a decade, based on a NerdWallet analysis of Federal Reserve and his own data. When the Fed raises its rate, as it did several times in 2022, banks usually raise their savings and CD revenue.
Without thinking, the best prices are in online establishments only. At the time of writing, you can find rates for 1-year CDs above 2.3% APY, three-year CDs above 2.7% APY and five-year CDs above 3% APY. In contrast, national average deposit rates are below 0.70%, which is still better than the national average of 0.13% on standard savings accounts.
Take this scenario: Put $10,000 into a CD at 3% for five years, and you’ll earn about $1,600 in interest. Try the same amount and time frame but in a 0.13% savings account, and you’ll earn around $65. I will choose the first option.
Unlike some checking or savings accounts, CDs have no monthly fees or minimum balance requirements other than the minimum to open. High yield CDs have a minimum range of $0 to $10,000.
CDs are the bank account equivalent to a safe deposit box. In exchange for high rates, you give up access to the funds. The first time you add money is always the only time you add money, so be OK with transferring a reasonable amount of cash to an account up front. Your money is then reserved for the CD period of your choice.
If you need to dispense a CD early, it can be a pain. You have to withdraw all the money in one transaction and pay a penalty that could cost several months to a year of the interest you earned – or would have earned. The bank can dip into your principal amount to cover the fine. Unlike other bank accounts, though, CDs only have one potential cost, and you can avoid it by waiting for the CD to mature.
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When do CDs work best for me?
CDs have more specific use cases than everyday checking and savings accounts. Ask yourself any of these questions before you decide to open a question.
1. Do I need more distance than some savings?
Suppose you received an inheritance or some other kind of windfall; or you built up savings for years; Or, you’re like my parents who – when I was growing up – put some savings into a stock certificate to keep it out of reach. Whatever the reason, a CD has been created to prevent you from being tempted to spend that money.
2. Do I have savings set aside for a large purchase?
If you have a car set aside or a down payment on a home in the next few years, the CD helps you set aside the money until you’re ready.
3. Do I want to protect some wealth outside of investments?
CDs provide short-term security, not long-term growth. The money is federally secured like in other bank accounts, which means your money will be returned to you even if a bank goes bankrupt. CDs also do not run the risk of fluctuation in value as in the stock market.
CDs are “in the middle between emergency savings and investment,” says Derek Brainard, national director of financial education at the AccessLex Institute, a financial literacy nonprofit.
Basically, CDs are cash reserves for short-term goals. Contingency savings should be available immediately if needed, while an investment — such as stocks or bonds — is for long-term wealth accumulation, Brainard explains.
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What if CDs aren’t right for me?
Giving up on the idea of high CD rates can be hard, but you’ll probably realize that losing access to funds isn’t worth it. You can still take advantage of the price environment by opening a high yield savings account. Like high-yield CDs, these accounts are mostly available at online banks and credit unions only. Many have interest rates close to 2% APY right now, and you can add or remove funds at any time.
Read also: 3 ways retirees can make the most of their money in an unpredictable market
I want a CD, but what if CD rates increase?
A fixed price CD can be a double-edged sword: it offers guaranteed returns, but if prices go up, you lose out on higher rates after you lock up your property. And the rates are increasing recently.
“If you believe that the price environment will continue, one strategy to offset this risk is to testify [or CD] Says CJ Pointkowski, assistant vice president of savings products at Navy Federal Credit Union.
Arranging CDs or creating a CD ladder involves opening multiple CDs with different terms – generally for short, medium, and long periods. The common ladder consists of one- to five-year CDs in which five CDs mature at staggered intervals, such as each year for the next half-decade. When each CD expires, you can reinvest in a new five-year CD to take advantage of higher rates in the future — or you can withdraw cash.
If juggling multiple CDs seems like a hassle, another strategy is to open a CD without penalty. This less common type of CD allows for a free early withdrawal anytime after the first few days, removing any hindrance to switching to a higher rate CD later. But prices alone should not guide your decision to open a CD.
“At the end of the day, CD will either be the right tool or not, regardless of what happens in the interest rate environment,” Brainard says.
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Spencer Tierney writes for NerdWallet. Email: email@example.com. Twitter: @SpencerNerd.