When Do CDs Make Sense as a Savings Strategy?

After an extended period of low interest rates, banks are finally starting to offer stronger rates on certificates of deposit (CDs). CDs require you to deposit money in a time-locked, loss-proof account in exchange for higher rates of return than more liquid savings accounts. So long as you understand their limits, CDs can be a useful part of your greater financial strategy.

What Are the Costs and Benefits of a CD?

Also called Share Certificates by credit unions, CDs come with several key advantages. As fixed-rate products with predefined terms, CDs offer guaranteed and loss-proof earnings. You'll know exactly how much you'll have at the end of the CD term. Unlike liquid savings accounts, most CDs beat the current inflation rate of roughly 1.9%. Rather than suffer an annual loss of value on your savings, you can use CD accounts to protect your assets against inflation.

CDs have some drawbacks as well: your money is tied up for the full term of the CD, making it harder to liquidate your assets as needed. Most banks let you withdraw your money ahead of schedule, but charge stiff early withdrawal penalties. Such penalties usually cost three to six months of earned interest, which will likely wipe out your gains. If rates are rising, CD owners also run the risk of missing out on riskier but higher-return investments.

What Rates Do CDs Earn Today?

The chart below offers some examples of CD rates. The providers listed below have some of the higher interest rate offerings in the marketplace. These rates are published on the websites of each provider and are subject to change.

Current 12-Month CD Rates

BankAPYMinimum Deposit
Citizens Access2.85%$5,000
Sallie Mae Bank2.85%$2,500
Marcus by Goldman Sachs2.75%$500
Synchrony Bank2.75%$2,000
Capital One2.70%none

What Are Some Alternatives to a CD?

The best all-around alternative to investing in a CD may actually be to pay off your existing debt. For example, the average interest rate on a credit card balance is many times higher than even the strongest deposit APY. Reducing your credit card debt will cut more dollars off your interest bill than you would earn with any deposit account. A proper savings strategy not only seeks better return, but also minimizes outflow.

Stocks

Investing in stocks is another common alternative. Some blue chip stocks earn quarterly dividends that post returns similar to a CD without locking your money in for a fixed deposit term. Besides dividend payouts, your initial investment can also rise in value as your chosen companies expand.

However, such benefits come with greater risk. Stocks can fall as well as rise, exposing you to potential losses you'd never face on a CD. Purchasing and selling stocks also incurs transaction fees that CDs don't charge. If you have a higher tolerance for risk, the higher rates of return in the stock market may be worth the potential for downturns in value.

Money Market and Roth IRA

If you have little high interest rate debt and prefer to avoid risk, money market accounts and Roth IRAs are both viable options. Money market accounts provide little return, but they also offer full liquidity and zero risk to your original balance. For long-term planners, a Roth IRA offers better return but penalizes any withdrawals you make before retiring. Because Roth deposits are made with after-tax dollars, withdrawals during retirement are considered tax-free.

What is a CD Ladder, and When Should You Use One?

A CD ladder is a strategy in which you purchase multiple CDs of different term lengths so that a portion of your total investment matures on a regular basis. By splitting your total balance into several products on a staggered schedule of maturity, laddering addresses the two main weaknesses of CD investment: rate risk and liquidity.

First, CDs lock in your rate of return for a long time, which causes you to lose out on better opportunities if interest rates go up in general during your CD term. Second, the funds put into a CD are illiquid, which means they cannot be converted into penalty-free cash until the term concludes. Laddering sacrifices a small part of your potential return in exchange for much greater flexibility.

As an example, let’s say you want to put $6,000 into CDs for three years. If you deposit everything into a single three-year CD, you won't be able to shift your investment if interest rates go up. Instead, you can divide the money into thirds. By putting $2,000 each into a one-year, two-year and three-year CD, you guarantee that at least some of your money will be up for reinvestment or liquidation on an annual basis.

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