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Having any savings on hand during a holiday season amid a year of record inflation is a pretty big accomplishment. And you probably didn't work that hard just to leave your money languishing in a brick-and-mortar bank account where it'll be lucky to earn a few pennies a year.
But knowing where you ought to stash your funds isn't always easy. A certificate of deposit (CD) is one option you may not have considered. Here's how to decide whether it's right for you.
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How a certificate of deposit (CD) works
Certificates of deposit (CDs) enable you to earn a high rate of interest on your savings, but you must promise not to touch your money for a certain amount of time, known as the CD term. This can be anywhere from a few months to several years, depending on the CD you choose. Generally, longer-term CDs have higher interest rates, but sometimes banks offer special promotional rates on some shorter-term CDs.
Once you've opened your CD, your rate is locked in for the full term. You'll receive periodic interest payments, which you can either spend or roll into your CD balance to help you earn even more in the future, thanks to compound interest.
Taking an early withdrawal from a CD results in penalties. This is different with every bank, but it's usually a few months' worth of interest payments.
Does investing in a CD make sense right now?
CD interest rates are the highest they've been in years right now, so you could lock in a high rate on your money by opening one. But high-yield savings accounts are offering high rates as well and these enable you to withdraw your money whenever you need it.
You have to decide if you're willing to sacrifice accessibility in order to earn a slightly higher interest rate. This might be worth it to you if you don't plan to spend the money in the foreseeable future. But it's not a good idea when you're talking about your emergency fund or money you think you'll need before the CD term is up.
If you don't think a CD is a good fit for you, a high-yield savings account is a great alternative. You'll still earn well above the national average interest rate on your savings, and since savings account rates aren't locked in, there's a chance you could earn even more over time if interest rates continue to rise like they have been all year. But there's also the risk that your rate could fall if interest rates drop.
How to open a CD
Opening a CD is pretty much the same as opening any other bank account. First, you must choose the CD term or terms you're interested in. If you just want to test the waters, you may want to begin with a short-term CD with a 12-month term.
Some people build CD ladders as a way to capitalize on the higher interest rates of long-term CDs without locking up all their funds for years. This is where you divide up the total amount you want to deposit equally among several CDs. For example, you might invest $1,000 in a 1-, 2-, 3-, 4-, and 5-year CD. Then, when the 1-year CD term is up, you roll it over into a new 5-year CD. You do the same thing with the 2-year CD the following year, and so on. This gives you access to some of your cash every year.
When comparing CD options, stay mindful of their minimum deposit requirements and their penalties for early withdrawals. Make sure you're comfortable with these terms before you place your money here.
It's not possible to predict what interest rates are going to do next year, so only you can decide if opening a CD is the smart decision for you. But with rates as high as they are right now, you'll probably earn quite a bit in interest with one of these accounts. However, if you're not comfortable with a CD's restrictions, you could do just as well with a high-yield savings account. Compare both options before deciding which is right for you.
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