A certificate of deposit (CD) is a savings account that pays a guaranteed interest rate, often based on how long you keep it in the CD. Longer terms often offer higher interest rates.
The problem with CDs is that interest rates fluctuate, and inflation can eat away at your principal and earnings. A longer-term CD may pay a higher interest rate, but interest rates may increase while your money is locked up the CD. You might miss out on a higher rate elsewhere. Understanding the best time to buy CDs can help you manage that risk.
- A CD is a bank account that pays higher interest the longer the money is put away.
- When interest rates are at their peak, it makes sense to buy a long-term CD.
- Laddering, barbells, and CDs that offer bump-up or no-penalty options are among the ways to get flexibility in CD accounts.
The Best Time To Open a CD
If you know when you need your money, you can buy a short-term CD now that matures on time. For example, if you have $10,000 saved for a house down payment but won’t look at real estate for another two years, you can put that $10,000 into a two-year CD. The money will be ready when you are.
For everyone else, the best time to open a CD is when interest rates are highest, then lock in that rate for a five-year-term or longer. Of course, that requires perfect foresight. As interest rates increase, CDs make sense for more savers. By understanding the relationship between interest rates, CD terms, and different CD features, you can decide about adding CDs to your portfolio.
You must weigh tying up your money in a CD and the interest gained against the risk that inflation will erode your spending power over that time.
The federal government insures bank and credit union accounts with CDs for up to $250,000. When the CD matures, you receive your principal along with accrued interest.
How Interest Rates Affect CD Timing
Interest rates are impacted by a variety of things, from recessions to high rates of inflation. When rates are rising, long-term CDs may look more attractive than in the past. But be careful—it may be unclear if rates will go even higher.
If you knew that interest rates were at their peak, you could lock your money into a long-term CD to enjoy those rates for years to come. But if you lock your money into one rate today, you might want a new, higher-rate CD in the future. You could close a CD account early, but the bank would charge you a penalty that could eat away your earnings. CD penalties are calculated differently depending on the CD and issuer. Regardless, it still may be worthwhile to close a low-interest-rate CD and move the money into a higher-rate CD.
It’s challenging to know when rates have peaked or troughed, though, and not everyone can lock away money for months or years at a time. Some common CD types can offer flexibility if interest rates increase in the future:
- No-penalty CDs: These CDs, also known as liquid CDs, allow you to withdraw your money at any time without penalty, after an initial funding period. While they may offer lower interest rates than CDs of comparable term lengths, you can withdraw cash and put it into a new, higher-rate CD if needed.
- Step-up or bump CDs: These CDs allow you to request a bump-up of your rate if the CDs’ rates increase during the term, generally two to four years.
When interest rates stay consistently low or go down, other types of accounts sometimes make more sense. That’s why it’s essential to shop around and compare financial institutions, CD types, and investment options.
Timing Strategies That Match Your Financial Goals
If you’re saving for a longer-term goal, such as a down payment or college tuition, you may be putting amounts each year into your CD while hoping to have at least some penalty-free access for emergency use. Two CD strategies may help in these situations: the ladder and the barbell.
The CD Ladder
Laddering CDs helps manage changes in interest rates and maintain regular access to cash. In essence, you distribute a lump sum across multiple CDs with different maturity dates, then roll shorter-term CDs into a longer-term CD as time passes. Here's an example:
- Year 1: You distribute $12,000 into three CDs of $4,000 each: one-year, two-year, and three-year CDs.
- Year 2: You roll the maturing one-year CD into a three-year CD for $4,000, or you can use the funds now. With many institutions, you can also add new funds to your CD at rollover.
- Year 3: You roll the maturing two-year CD into a new three-year CD for $4,000. You now have a CD that expires next year, in two years, and in three years.
Suppose interest rates stay steady during this period. In that case, your ladder provides the higher rates associated with a longer term while still having regular access to your money, if you need it, reducing the risk of paying early withdrawal penalties.
The CD Barbell
A CD barbell involves taking a sum of money and investing it into CDs with different terms but without the rollover aspect of a ladder. For example, suppose you had $7,500 to invest and did not want to lock all of it up for five years, but wanted to earn higher interest than a one-year CD. You could put $3,500 in a five-year CD and $3,500 in a one-year CD. This is known as a barbell and can increase interest while still having some penalty-free access to the money.
An IRA CD is another approach for retirement investing, although you should weigh the pros and cons of an IRA CD.
Alternatives to CDs When Rates Are Low
CDs are only one of many fixed-income investments or accounts that pay regular interest income. When rates are low, other types of accounts may offer better returns for the risk taken. These include high-yield savings and money market accounts, and bonds.
High-Yield and Money Market Accounts
High-yield checking and high-yield savings accounts advertise higher interest rates than comparable bank accounts, and your cash is always available. Likewise, a money market account has a fluctuating interest rate and allows regular access to your cash without any minimum time requirements. Many banks and credit unions offer federally insured money market and high-yield savings accounts with higher interest rates than regular savings accounts.
Always compare options. For example, if you opened a 12-month CD with a rate of 0.25%, but a high-yield savings account offered 0.50% interest for the year (APY), you may be better off opening a high-yield savings account. Or if a five-year CD pays 3.5% and a high-yield account pays 3%, the higher rate may not be worth waiting to access funds.
Many brokerage firms and fund companies offer money market accounts that are not insured, including money market mutual funds.
A bond is a loan type that pays regular interest and returns the principal at maturity. These have many risks, including that the loan will not be repaid. Investors can buy corporate bonds through their broker or investment sites, and government bonds through TreasuryDirect.gov. There are also many bond mutual funds and ETFs, including high-yield bond funds. Government bonds are slightly more risky than CDs (with a corresponding slightly higher risk of return), and high-quality corporate and municipal bonds are slightly more risky than government bonds, according to research from the University of Nebraska Lincoln Extension.
Frequently Asked Questions (FAQs)
How much money do you need to open a CD?
The minimum deposit varies by the financial institution, ranging from $0 to $25, to $500 or more for a jumbo CD.
Where should you open a bank CD account?
Almost every bank and credit union offers CD accounts. Many brokerage firms offer both insured and uninsured CDs as well. Because there are so many places to get CDs, it makes sense to shop around and compare the best CD rates, along with terms, penalties, and other factors. Ensure that any CD you open is FDIC or NCUA insured.