Alternatives to CDs
If you’re not looking to tie up your money for a while and want easier access to it, you might consider opening a high-yield savings account as an alternative. Below are some savings account options from our partners that may be competitive with the rates you can earn on CDs. It should be noted that unlike a CD, where your rate is locked in, with a savings account the bank or credit union can change your rate at any time.
Advantages and disadvantages of CDs
Offers a higher rate than you can earn with a savings or money market account
Pays a guaranteed and predictable rate of return, avoiding volatility and possible losses with stocks and bonds
Is federally insured if opened with an FDIC bank or NCUA credit union
Can help fend off temptations to spend as withdrawing funds early incurs a penalty
Cannot be liquidated before maturity without incurring an early withdrawal penalty
Typically earns less than stocks and bonds over time
Earns a fixed rate of return whether or not interest rates rise during the term
How much do CDs cost?
While the national average is a good indicator of where rates are heading – and how they’re moving over a period of time – it’s not what you need to consider when buying CDs. Instead, look for the best rates available nationwide, which are well above industry averages.
Take one-year-old CDs, for example. The current national average is only 0.16% annual percentage yield (APY). However, today’s highest paying institution will pay you 0.90% APY on that same one-year commitment, more than five times as much. Similarly, for three-year CDs, you can currently earn 1.30% APY instead of the industry average of 0.25% APY.
If you have the money you can park for a while, but you want to earn more than the best savings and money market accounts will earn you, our research into the best rates available nationally in each term CD major can lead you to maximum returns. .
Keep in mind that CD yields are always taken into account taxable as interest income at the state and federal levels, which will impact the total return you can achieve.
How does a CD work?
Opening a CD is very similar to opening a standard bank deposit account. The difference is what you agree to when you sign on the dotted line (even though that signature is now digital). Once you’ve shopped around and identified the CD(s) you’re going to open, completing the process will lock you into four things:
- The interest rate: Locked rates are positive in that they provide a clear and predictable return on your deposit over a specific period of time. The bank cannot change the rate later and therefore reduce your earnings. On the other hand, a fixed yield can hurt you if rates rise significantly later on and you’ve lost your chance to take advantage of higher paying CDs.
- The term: This is the length of time you agree to leave your deposited funds to avoid any penalties (e.g. CD 6 months, CD 1 year, CD 18 months, etc.) The term ends on the “due date when your CD has matured and you can withdraw your funds without penalty.
- The main: With the exception of some specialty CDs which allow additional deposits, this is the amount you agree to deposit on the CD, upon opening.
- The institution: The bank or credit union where you open your CD will determine aspects of the deal, such as early withdrawal (EWP) penalties and whether your CD will be automatically reinvested if you do not provide further instructions at the time of the deal. ‘deadline.
Once your CD is established and funded, the bank or credit union will administer it like most other deposit accounts, with monthly or quarterly statement periods, paper or electronic statements, and usually monthly interest payments. or quarterly deposits to your CD balance, where the interest will be compounded.
What is a CD ladder and why should I build one?
Smart CD investors have a specific tactic to hedge against rate changes over time and maximize their return. It’s called a CD scale and it lets you access the higher rates offered by 5-year CD terms, but with the twist that some of your money becomes available every year, rather than every five years. Here’s how.
Initially, you take the amount of money you want to invest in CDs and divide it by five. You then put one-fifth of the funds into a top-earning 1-year CD, another fifth into a 2-year CD, another into a 3-year CD, and so on down to a 5-year CD . Let’s say you have $25,000 available. This would give you five CDs of varying length, each worth $5,000.
Then, when the first CD matures in a year, you take the resulting funds and open a top-rated 5-year CD. A year later, your original 2-year CD will mature and you will invest those funds in another 5-year CD. You keep doing this every year with any maturing CDs, until you end up with a portfolio of five CDs all earning 5-year APYs, but with one of them maturing every 12 months, keeping your money a little more accessible than if all of it was locked away for five years.
What is considered a good price for a CD?
What makes CDs attractive as an investment vehicle is not their rate of return but their risk-free nature. When you open a CD, you know in advance exactly what interest rate you will earn and for how long. With the exception of some specialty CDs, your certificate rate is guaranteed and locked for the life of the certificate, meaning your return is predictable and secure.
Adding to their risk-free nature is the fact that CDs, like other bank and credit union deposit products, are federally insured against bank failure. Depending on the financial institution offering them, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).
CD minimums can be as low as $250 or $500, and you’ll find plenty of options with minimums up to $1,000. As for terms, the majority of CDs have terms of six months to five years, although shorter and longer certificates exist at some banks. Larger deposits and longer terms generally earn higher interest rates, although promotional certificates often violate this general rule. The interest rates available on the highest paying CDs are generally in line with the current rate of inflation, so virtually any rate above that is a bargain. Often, online banks and credit unions offer the best CD rates.
Maximize your CD’s rate of return
The #1 strategy for earning as much as possible from a CD investment is to diligently research the best rates. After that, the second most important strategy is to keep the invested funds for the duration of the CD, to avoid incurring an early withdrawal penalty that will reduce your earnings.
But unexpected things happen in life and you may have no choice but to cash in on a CD early. Because of this possibility, you will be well served by paying attention to the early withdrawal penalties of the various CDs you are considering before making a final commitment.
It’s also useful when comparing two fairly similar CDs, to check their composition periods. The advantage of having interest calculated and compound accumulates more often over time, so avoid CDs that only offer annual compounding.
While CDs are traditionally a fixed rate investment, variable rate CD exist. If you think interest rates are likely to rise significantly, you may qualify for a certificate where the interest rate is adjusted over the term of the CD. These certificates are sometimes referred to as “raise your rate” or “step up” CDs.
Meanwhile, indexed or structured CDs offer you the opportunity to earn a percentage of the return of a stock index or commodity index. This can result in a much higher return than a traditional CD, but for a trade-off with much more risk.
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