Mistakes To Avoid With a CD

Don’t make these 5 common CD mistakes

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Certificates of Deposit (CDs) can be a valuable part of your investment strategy. They often help you earn more than you would with a traditional savings account while offering predictable payouts. 

That said, there are a few ways investing with CDs can have downsides. Read on to learn about five of the most common CD investing mistakes and how to avoid them.

Key Takeaways

  • CDs require you to deposit a fixed amount for a set period to earn a return.
  • In most cases, taking money out of a CD early will result in an early withdrawal fee.
  • CDs might not be your best financial move, especially if you have high-interest debt.
  • If rates are rising, you could lose buying power by investing in a CD, so you may want to consider a CD ladder.

How CD Investing Works

When you invest in a CD, you deposit a fixed amount of money into a savings account for a set amount of time to earn interest. CD terms typically range from one month to five years, but you can find CDs for 10 years or more. When your term ends, you get back your initial deposit plus the interest you’ve earned.

The interest rates can be fixed or variable and will vary from CD to CD. However, no matter what interest rate you get, you typically need to leave your principal in the CD until the maturity date to get the full yield. Early withdrawals often come with penalties that reduce or negate your interest earnings. 

For example, say you sign up for a 1-year CD that requires a $5,000 minimum deposit and pays a fixed 1.05% APY. You would get back approximately $5,052.50 at the end of the one-year term. If you pull out your money after just six months and the CD has a three-month early withdrawal penalty, you would only get $5,013.12 back (three months of interest).

5 Common CD Investing Mistakes To Avoid

While CDs can offer a number of benefits to investors who are looking for low-risk assets with predictable returns, they have some downsides to consider. If you invest in CDs, you’ll want to use them toward your broader financial goals. Here are five mistakes to avoid.

Withdrawing Your Money Too Soon

Investing in a CD and withdrawing your money before the maturity date can cost you. CDs are designed to reward you with higher interest rates than a savings account because you agree to leave your money in them for a certain amount of time. If you take your money out early, you’ll typically have to pay an early withdrawal penalty. The penalty cost and rules vary from one bank to the next so be sure to compare them before choosing a CD.

Liquid CDs are CDs that don’t charge you a penalty for withdrawing your principal early, but they typically offer lower interest rates. 

Opening a Fee-Based Account First

Banks and credit unions may require you to open up a checking account before you can get a CD or preferred CD rates from them. That can be a problem if the checking account comes with any costs. While the best CD rates can top 2%, the national average return rates ranged from 0.03% to 0.28% as of March 21, 2022. In short, the earnings are often modest so fees from checking accounts can reduce your returns.

For example, Chase recommends opening a checking account so you can get special CD relationship rates. However, Chase Total Checking has a $12 monthly service fee. The fee can be waived if you keep at least $1,500 in the account at all times, make at least $500 in electronic deposits per month, or have $5,000 total in a combination of Chase accounts. Without the waiver, that $12 monthly fee can cost you more than you’ll earn per month from Chase’s CDs.

If a bank requires you to open a checking account to open a CD, be sure to look into the costs first to see if it makes sense. 

Using CDs Instead of Better Investments

CDs are low risk but they are also low return. So, it can be a mistake to invest your money into CDs before investing it in other accounts that offer higher returns or more liquidity.

“Realistically, having money that is dedicated to long-term goals tied up in a CD isn't competing with the rising cost of goods and services over time, especially the further out you are from retirement.” Marigny deMauriac, CFP, of deMauriac Financial Consulting and Wealth Management, told The Balance in an email.

Consider which investment types will align with your goals for risk tolerance, liquidity, and returns, and then prioritize your investments accordingly. For example, an IRA and 401(k) can offer higher long-term returns, while a high-interest savings account may be able to offer you similar returns with better liquidity. 

Opening a CD When Rates Are Climbing

Investing your money into a longer-term CD can work against you when interest rates are rising.

“The safe feeling a CD may give you shouldn't feel quite as safe when the rate of inflation is easily double or triple what a CD pays right now in interest,” deMauriac said. “Purchasing power risk is one of the biggest risks to your money and that's something people routinely forget when investing only in CDs.”

Opening a CD amid rising rates means you may miss out on higher returns,  Ryan Ortega, Financial Advisor at Third Line Financial told The Balance in an email. “By tying up your money for too long (in a CD), you miss out on the opportunity to get more yield if rates rise substantially,” he said.

For example, if you locked your money into a 5-year CD at 0.50% APY and then the same CD was offered with a 0.75% rate three months later, you would miss out on that extra interest. So when rates are rising, it’s better to wait, keep your investments short-term, or opt for a CD ladder. 

CD laddering is a creative approach to help you get higher interest rates and more liquidity. It involves splitting up your investment between CDs with various terms so that they mature at regular intervals, Nate Hansen, of SuperfastCPA, told The Balance in an email. 

“Instead of locking $10,000 into a 5-year CD, you could invest $1,000 every six months into a mix of short and long-term CDs,” Hansen said. “This gives you faster access to your invested funds each year as the different CDs mature. Then, you can put the money back to work in more time-relevant options.”

Opening a CD Instead of Paying Down High-Interest Debt

Lastly, when deciding how to invest, don’t forget to take your existing debts into account alongside your investment options. If you have debt that’s costing you more than a CD can earn you, investing in the CD will be a mistake. 

For example, say you have a $1,000 installment loan with a 12% APR. That means you’ll pay $120 in interest over the next year while paying the loan off. If you have $1,000 but decide to invest it into a one-year CD with a competitive 1% APY, you’ll earn just $10 over the course of the year. Overall, you’ll have a net loss of $110. If you pay off the $1,000 loan instead, you’ll save the $120 so would be in a better position. 

It can make more financial sense to pay your high-interest debt off before you begin investing to earn modest returns.

The Bottom Line

CDs are considered a low risk investment and they can offer modest, predictable returns that you can count on. Research interest rates before investing, prioritize paying off high-interest debt, and consider your other investment options. You may want to avoid investing money long-term if you might need it sooner.  

Finally, consider CD laddering to increase your liquidity, especially in an environment where interest rates are rising. 

Frequently Asked Questions (FAQs)

When would a CD be the best choice?

CDs can be a great way to safely store money for short periods, but the low interest rates often won’t be competitive enough to keep up with inflation and rising interest rates long-term. CDs are typically FDIC insured for up to $250,000.

What is the minimum balance for a certificate of deposit?

The minimum balance for a certificate of deposit will vary from one financial institution to the next and can vary between CD offerings at the same institution. Some banks don’t have any minimum balance requirements.

How do you buy a certificate of deposit?

To buy a certificate of deposit, you’ll need to find a bank or credit union that offers CDs that match the rates and terms you are looking for. Then, you’ll follow the financial  institution's steps to open the account. That typically includes completing an application, agreeing to the terms, and making a deposit. 

Article Sources

  1. U.S. Securities and Exchange Commission. “Certificates of Deposit (CDs)

  2. Federal Deposit Insurance Corporation. “FDIC: National Rates and Rate Caps.”

  3. FDIC. “FDIC: National Rates and Rate Caps.”

  4. Chase Bank. “Open a Chase Certificate of Deposit Account.”