The interest rate represents the fixed interest rate you receive, while APY refers to the amount you earn in one year, taking compound interest into account. First, when do you need the money? If you need it soon, consider a CD with a shorter term. Also, consider the economic environment. If it seems that interest rates may rise, or if you want to open multiple CDs, CD laddering can be a good option.
However, if rates go down, you benefit: You still earn the higher rate that was offered when you opened the CD. CD laddering, buying multiple CDs of varying term lengths, can help address this concern. It can also be a way for you to take advantage of longer terms and therefore higher interest rates while still giving you access to some of your money each year. With a CD ladder, you divide your initial investment into equal parts and invest each portion in a CD that matures every year. As each CD matures, he reinvests the money at the current interest rate or uses the cash for another purpose.
If Leo reinvests his money, he might choose a new 5-year CD, which would ensure he has one CD maturing each year as long as he continues laddering. CDs are available in various terms ranging from six months to five years or longer. Longer-term CDs usually pay more than shorter-term CDs because your commitment is greater, but there are exceptions. Some CDs also adjust the interest rate you earn over time. CDs are relatively safe investments when it comes to the risk of losing money in your account.
They are best for situations when you cannot accept the risk of losing your money. Note For longer-term goals, like a retirement that is more than 20 years away, CDs might or might not be the right investment. You can often set up CDs online, especially at online-only banks. When your CD matures , you should receive a notice explaining your options. There are several other types of CDs that allow for flexibility when it comes to withdrawals and interest rates. Check with your bank to find out what options are available to you.
You may also want to shop around at multiple banks and credit unions to find the best CD choices and rates. However, if you want to optimize your CD investing, there are several ways to manage your CDs. Laddering is a strategy of buying multiple CDs with different maturity dates—from short-term to long-term maturities.
This helps you keep money available and avoid investing all of your money when interest rates are at their worst. A barbell approach sticks to short and long-term CDs while skipping medium-term CDs. If medium-term interest rates are unattractive, you can just steer clear of them.
If you hire somebody, they may use brokered CDs , which are a little different from plain vanilla CDs in your bank account. Be sure to ask the following questions of any investment manager: Are my funds insured by the U.
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Do you want to save for your own retirement or to save for college for your children? Or does this money have a specific purpose, such as a down payment on a house, a home renovation, a vacation or some other particular goal in the near future? If the money that you are considering putting into a CD is intended to be part of your emergency fund , you may or may not want to put it into a CD.
Most CDs will assess a penalty if you withdraw your savings before their term is up. Ideally, your emergency fund should be as liquid as possible. If you lose your job or get in a car accident tomorrow, you need to be able to get quick access to your emergency cash savings. If this money is meant for longer-term savings goals, like college education expenses for children or grandchildren, or retirement savings, you probably should not put it into a CD.
So, depending on your financial situation, the best reason to put money into a CD might be if you have a specific, short-range savings goal, such as saving money for a down payment. If you want to get the best possible yield on your savings in the short term, while not risking your principal, a CD may be the best option. How soon might you need to access this money?
This is an important question, because CDs require you to lock up your money for a specific term. It might be one year or up to five years, depending on which CD you choose. But CDs are not the same as a cash savings account or checking account , where your money is more immediately accessible. What yield can you expect to earn on the CD? The rates paid by CDs change constantly depending on broader changes in interest rates and ongoing competition among financial institutions.
How long will your money be tied up in the CD? Banks and credit unions offer a wide range of certificate of deposit terms, ranging from as little as one month to as much as five years or more. Depending on how long you are willing to commit your money to being deposited in the CD, you can typically earn a higher APY with a longer-term CD. However, if you expect to need access to your money in less than a year, you might want to put your money into a high-yield online savings account instead.
Many online savings accounts are offering APY rates that are competitive with or even higher than CDs. What are the penalties for early withdrawal? If you decide to pull your money out of the CD before the term is up, in most cases you will have to pay an early withdrawal penalty.
Before committing to a CD, read the fine print. Early withdrawal penalties tend to vary by bank or credit union, but typically they charge penalties based on a certain number of days or months of interest paid by the CD. Longer-term CDs tend to have larger penalties for early withdrawal. After all, once you have a CD, you lock in that rate for months or years. At the same time, you still get the guaranteed returns and federal insurance that CDs offer.
When each CD matures, you reinvest in a long-term CD. Ideally, you repeat this until you have a five-year CD maturing every year. But if you need funds one year, you can opt to withdraw whichever CD is maturing soon instead of reinvesting.
Typically the longer a CD term, the higher the rate. But if you stick with only long-term CDs, you lose access to that money for years. A CD ladder provides a middle-of-the-road approach: regular access to some funds while earning long-term CD rates.
Make sure you have an emergency fund before investing in CDs. When the short-term CDs mature, you either reinvest in short- or long-term CDs, depending on whether rates across the industry have risen. If five-year rates have gone up, reinvest the money in a five-year CD. Half your funds might stay in short-term CDs awhile if rates stay flat or drop.
Thanks to frequent maturities, though, you can choose to put that money elsewhere. You also hedge bets by taking advantage of current long-term rates. Generally the overall return tends to be an average of short- and long-term CDs. What to remember: A CD barbell is less diversified than a CD ladder, which makes it riskier in the sense that you might miss out on higher rates in the future.
You can put more money on the short- or long-term end of a barbell, but this might make sense only if you understand — or speak to a financial advisor about — how current financial markets impact the direction of CD rates. If you open CDs over time, new terms will be shorter than the initial CD. If you only open one CD, it can technically be considered a CD bullet. How it can work: Say you plan to buy a house in five years, so you put money in a five-year CD.
Two years in, you can afford to put another chunk of money into a CD, and choose a new one that will mature around the same time as the initial CD. Four years in, you put more savings into another, much shorter CD. Once the fifth year ends, all CDs mature. A CD bullet strategy can be a workaround: You can get shorter CDs over time, almost like a reverse CD ladder, to earn more interest on funds that you saved up since the initial CD.
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