The Federal Reserve’s significant hikes in interest rates this year are painful for consumers who carry credit card balances or need loans to buy homes, cars and other goods. Aggressive rate hikes have also negatively impacted the stock market.
But there is a positive side to these interest rate movements, and that is that they provide growth opportunities for savers. As interest rates rise, banks and credit unions usually follow suit and begin paying higher yields on deposit products, such as certificates of deposit (CDs).
Reasons to invest in CDs
With inflation at 40-year highs and a bearish stock market, CDs are a savings tool worth considering for several reasons:
- Annual Percentage Returns (APYs) on CDs are on the rise, so the earning potential is growing.
- Rates on standard CDs are fixed. Unlike the stock market, which fluctuates, CDs offer reliable returns.
- CDs may pay more than other deposit accounts, such as savings and money market accounts.
- CDs make planning and budgeting easy because savers know exactly how much they will earn over a given time and when the money can be withdrawn.
- You can create a steady stream of income for yourself by laddering CDs.
- CDs at federally insured banks and credit unions are protected.
“The outlook for CD investors for the coming year is much better than what they’ve experienced in the past three years,” said Greg McBride, CFA, Bankrate’s Chief Financial Analyst. “Interest rates will rise and eventually inflation will fall.
“This is quite a reversal of the environment of declining CD yields and then rising inflation from 2019 to 2022.”
Tips for choosing the best CD
Perhaps the most important thing to do before putting money on a CD is to set your goals. Map out your financial situation and determine what you want to achieve with your investment.
Before opening a CD, make sure you have enough money in your emergency fund, at least three to six months of living. This is money that should not be locked up on a CD, but is better off in a liquid savings account.
1. Determine the correct term length
CDs typically require you to invest your money for a set amount of time called a term. During the term, you agree not to withdraw the funds.
CD terms can range from as short as a month to as long as five years, seven years – even 10 years at some banks. Therefore, you need to know what your goals are and how much money you can afford to commit and for how long.
Are you saving to buy a car, go on vacation, or put down a down payment on a house? Determine when you need that money to pick a CD with the right run time.
“Because of early withdrawal penalties, it’s important to match the point at which you need the money to the CD’s runtime,” says McBride. “No-penalty liquid CDs exist and are a consideration, but often have lower returns due to their flexibility.”
2. Shop for the best rates
With every investment product, the aim is to grow your money as much as possible. National averages for CD rates are low compared to what you can find by shopping around. For example, the national average for a one-year CD is just 0.96 percent APY, according to Bankrate’s latest weekly survey. But there are banks – especially online banks – that pay 3 percent APY and above.
Online banks often pay better rates because they don’t have the overhead of maintaining branches that traditional brick-and-mortar banks have.
Bankrate.com does the work for you by finding the best CD rates for a wide variety of CD terms.
3. Choose a CD with a minimum deposit you can afford
Financial institutions differ on the amount of deposit required to open a CD. Some banks, such as Ally Bank and Synchrony Bank, do not have deposit minimums.
However, many banks require you to deposit a minimum of $500 or $1,000. Others need $5,000 or more. The minimum deposit requirement may depend on the type of CD you open. Jumbo CDs often require $100,000 deposits.
Your deposit is secured for the CD term, be it a year or five years or more. Choose a CD with an opening deposit that you can afford to keep investing until the CD matures.
4. Check for early withdrawal penalties
Banks punish CD account holders who withdraw their money before the CD expires. Read the fine print of your account agreement to find the details of these charges.
Early withdrawal penalties can vary widely, from 60 days of interest to 365 days or more of interest. Typically, the longer the CD term, the higher the fines.
If you open a CD through a broker, you pay a fee. But since it’s easy to find the best CD rates and products on your own, it hardly seems necessary to pay a broker to do this for you.
5. Choose the right type of CD
CDs come in many varieties and it is smart to know what they are because you may find one that suits you better than a traditional CD.
For example, a no-penalty CD, sometimes called a liquid CD, won’t penalize you for withdrawing your money before the term expires. If you think you may need the money before the CD matures, or if you want the option to withdraw it penalty-free to pursue a better investment, a no-penalty CD may be a good choice. The trade-off is that the APY will likely be lower than on a traditional CD.
If you’re expecting a nice bonus at work, consider an add-on CD, which allows you to add money to the account over the term. IRA CDs are an alternative that typically has lower yields, but they have tax benefits.
Bump-up and step-up CDs are slightly different, but both products allow you to earn higher returns as rates rise.
Discover different types of CDs and make the best choice for your circumstances.
6. Find a Federally Insured Bank or Credit Union
Shop only at banks and credit unions protected by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Association (NCUA) Share Insurance Fund. If your bank or credit union were to fail, your money would be protected.
Federal deposit insurance covers up to $250,000 per depositor, per FDIC bank, per account ownership category. Some banks offer a service that distributes money to a network of insured banks to give customers with large deposits more insurance coverage.
What it comes down to:
A CD can be a safe, high-return investment if you can lock in the money for a certain period of time. To get the most out of your money, shop around for the best rate, select a term you’re comfortable with, and go with a bank or credit union that is federally insured.