Certificates of deposit (CDs) can offer higher yields than traditional savings accounts, so they’re a good choice if you want to lock in your funds for a period of time. CDs typically have terms ranging from three months to five years, and their guaranteed annual yield (APY) makes them valuable even in a declining interest rate environment.
The right CD term for you depends on when you need to get your money. Generally, the longer the CD term, the higher the APY can be. Federal Deposit Insurance Corporation (FDIC) banks and National Credit Union Administration (NCUA) credit unions often offer both CDs and at least one savings account.
Because there can be penalties for withdrawing funds early, CDs are best suited for people who already have an emergency fund easily accessible in a savings account.
short term CD
Short-term CDs typically have a term of up to one year. Putting money into a short-term CD allows you to maximize the interest you earn on funds earmarked for near-term purchases, such as an upcoming vacation, home renovations, or next year’s holiday gifts.
Short-term CDs can be used as a component of a CD ladder that purchases multiple CDs with staggered maturity dates. This savings strategy includes short-term, medium-term, and long-term CDs, giving you regular access to funds with the benefit of long-term CDs’ higher interest rates.
Advantages of short-term CD
The advantage of short-term CDs is that you can access your funds relatively quickly, so you may be less likely to have to withdraw your funds before the CD matures and be subject to early withdrawal penalties.
Disadvantages of short-term CDs
A potential disadvantage of short-term CDs is that they may yield lower returns than long-term CDs. Banks want you to keep your money for a long time, so they tend to offer the best interest rates for the long term.
Additionally, while you may need the funds from a short-term CD relatively quickly, you may lose much of the interest if you withdraw the money before the CD matures, so you may need the money in a liquid savings account. It’s not as accessible. For example, if you withdraw your one-year CD early, you may incur a two- to six-month interest penalty.
Why are short-term CD rates higher than long-term CD rates?
If you’ve compared CD rates recently, you may have noticed that short-term CDs earn competitive rates. Long-term CDs typically earn the highest interest rates. However, in the current high interest rate environment, with interest rate declines on the horizon, the opposite is likely to happen. The federal funds rate affects the CD rate. The higher the federal funds rate, the higher the CD rate. Banks don’t want to be stuck paying high interest rates on long-term CDs when the federal funds rate is high and rates are likely to fall in the near future. Instead, it makes short-term CDs more attractive at higher rates.
midrange cd
Mid-range CDs may include those with terms greater than one year and up to three years. Some people may open a mid-range CD in preparation for purchasing a new car or a planned life event such as getting married or having a baby.
Advantages of midrange CDs
Instead of locking up your money for a little longer than needed for a short-term CD, you may be able to earn a slightly higher rate with an intermediate-term CD. Midrange CDs are also more flexible than long-term CDs, requiring only a 1-2 year commitment instead of 3-5 years.
Disadvantages of midrange CDs
Midrange CDs tend to earn higher yields than short-term ones, but not everyone can tolerate not having access to some of their funds for several years. This is especially true for those who don’t have an easily accessible emergency fund.
CD that can be stored for a long time
Long-term CDs typically range from 3 to 5 years. These accounts can help you earn significant interest on the funds you plan to use over the next few years, such as making a down payment on a home or building an addition to your home.
Advantages of long-term storage CDs
If you agree to lock up your funds for a few years, you can earn much higher returns than you would receive from many short-term CDs. For example, if you invest $5,000 in a CD for five years at the currently available 3.5 percent interest rate, you’ll have approximately $5,938 left over when the CD matures. That’s because you’ll earn about $938 in interest. However, if you invested the same amount of $5,000 in a one-year CD paying 2.5 percent, you would have $5,125 at the end of the year, which includes about $125 in interest.
A CD calculator can help you figure out your final balance when your CD matures.
Long-term CDs are a good investment when interest rates on deposit products start to decline and appear to remain low. If you lock in a high interest rate now, you’ll be sure to get that return even if interest rates plummet.
Disadvantages of long-term CDs
With long-term CDs, your funds won’t be released for several years, so you could lose out on better yields if interest rates rise during that time. Additionally, CDs may not keep up with inflation, in which case your money loses purchasing power.
Another potential downside to long-term CDs is that if your financial situation deteriorates due to factors such as a spike in inflation or an unexpected job loss, it may be difficult to keep your funds there for several years .
Assemble the CD ladder
A CD ladder is a savings strategy that leverages the benefits of short-term, medium-term, and long-term CDs. To build a CD ladder, you need to open multiple CDs of varying lengths and stagger their maturity dates at regular intervals. For example, you can build a CD ladder using 1-year, 2-year, and 3-year CDs.
As each CD matures, you can withdraw your money or reinvest it to continue on the CD ladder. This strategy creates revolving access to a portion of your savings and reduces the risk of incurring early withdrawal penalties. Additionally, you can take advantage of competitive rates by building CD ladders with different criteria, regardless of which type of CD currently offers the highest rates: short, midrange, long, etc. can.
CD without penalty
If you want a fixed interest rate but are concerned about the possibility of needing the funds before the term ends, consider a penalty-free CD. These CDs allow you to withdraw funds before the CD’s maturity date without paying penalties. (However, withdrawals are generally not allowed within one week of opening a penalty-free CD.)
No-penalty CDs often come with a term of 6 to 14 months. In exchange for having access to your money, you often pay a lower rate than a CD, which has such penalties. When considering a penalty-free CD, it’s helpful to compare the interest rate to the interest rate on a savings account or money market account, in case you find a higher yield elsewhere.
Find the CD with the best rate
No matter what period of CD you’re looking for, you’ll get the best rate on CDs. Online-only banks, which don’t have the cost of maintaining a branch, usually offer the best interest rates.
Additionally, CD interest rates can be relatively high because the credit union’s profits are passed back to its members. This could lead to higher APYs on deposit products and lower interest rates on loans.
CD alternatives
Because a CD locks in your money for a set period of time, other types of accounts may be a better choice in some cases. For example, if you need money quickly to cover unexpected expenses, such as car repairs or medical expenses, it’s better to keep it in a more liquid, high-yield savings account than in a CD, which avoids early withdrawal penalties. It is wise because it is not subject to.
You may have other funds that you don’t plan on accessing in the near future (such as funds set aside for retirement), but this money may be better invested elsewhere than in CDs. You can earn significantly higher yields from investments such as S&P 500 index funds, 401(k) accounts, and traditional IRAs. A thorough understanding of your investment options (which may require hiring a financial advisor) will help you make informed decisions.
conclusion
While the length of a CD’s term can affect your rate of return, ultimately choosing a short-term, medium-term, or long-term CD is based on when you need access to your funds. It will be. By shopping for the right term and highest yield, you can reach your financial goals.
—Freelance writer Emily Butdorff contributed updates to this article.
