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Should I Use a High-Yield CD for My Savings?

Laura answers a listener question about using a CD to stash her cash. Find out what a CD or certificate of deposit is, where to find high-yield CDs, and how to use them wisely if they're right for you.

By
Laura Adams, MBA
7-minute read
Episode #638
CD bank loans
The Quick And Dirty

CDs offer safety and a guaranteed return--but they don't always pay more than other types of deposit accounts. If you've fully funded your emergency savings and still have cash that you want to keep safe or earmark for future financial goals, such as buying a home or retirement, using one or more CDs can make sense.

Anna from Washington D.C. says:

Thanks for putting out a great show. I've been listening to the Money Girl podcast for several years, and your straightforward advice and information has helped me make good money decisions. I share your work with everyone. 

Here's my question: I keep the majority of my money in a high-yield savings account that used to offer 1.7% APY. However, due to the Federal Reserve lowering interest rates in response to the economic impacts of the COVID-19 pandemic, my bank recently reduced the rate to 1.55% and then to 1.3% APY. 

This rate reduction is obviously frustrating for me as a customer, but I understand that a lot of this is outside of anyone's control in these trying times. My bank is offering a CD, which earns a 1.55% APY, which seems attractive given the additional boost. However, I'm not really sure what the pros and cons are for CDs. And to be honest, I'm not exactly sure what a CD is. 

I keep my six-month emergency fund savings in this high-yield savings account, and I'm trying to save for a down payment on a house. I want my emergency fund to be readily available in these uncertain times. But I probably won't need to touch my down payment savings for at least another year or two, or maybe more, since the housing market is very expensive in the D.C. area.

Does moving my money to a CD make sense, or should I just keep it in the high-yield savings account and hope that the rate will eventually increase again?

Thanks for your kind words and thoughtful question, Anna! I'll answer it by explaining what a CD (certificate of deposit) is and how to use one wisely. You'll get an overview of the different types of CDs and learn the best places to find high-yield CDs if they're right for you.

What is a CD?

A CD is a product offered by financial institutions, including banks, credit unions, investment firms, and insurance companies. It's different than a savings or money market account because you give up access to your money for a period or term. 

A CD gives you a guaranteed return, albeit a low one right now, no matter what happens to the economy or the financial markets.

In exchange for agreeing not to touch your money during a CD's term, you typically get more interest than with other types of deposit accounts. A CD gives you a guaranteed return, albeit a low one right now, no matter what happens to the economy or the financial markets. There are two ways to measure interest for CDs: APY and APR. 

APY, or annual percentage yield, is the rate you receive if all the interest you earn gets added back to your balance, which is called compounding. In other words, APY is the rate you get if you never withdraw interest from a CD.

APR, or annual percentage rate, is the rate of interest you earn without taking into account the effects of compounding in that year. It's the rate you receive if you withdrew every penny of interest and didn't have any compound growth. When you see a CD rate that doesn't say it's the APY, you should assume it's the APR.

If you purchase a CD that has FDIC (Federal Deposit Insurance Corporation) or NCUA (National Credit Union Administration) insurance, you're covered for up to $250,000 if the institution fails for any reason. This amount includes your principal (that's your original deposit) and interest earnings in the account. Some institutions that aren't banks (such as insurance companies) offer CDs with FDIC insurance. But some don't offer the insurance, so be sure to check.

The minimum amount required to open a CD is generally $500 but could be much higher depending on the institution and type of CD. You can put an unlimited amount of money into a CD, but to be safe, stay under the FDIC or NCUA limit of $250,000 per account holder per institution.

What is the CD Withdrawal Rule?

With any CD, your money is locked up for a specific term that might range from a few months to five years. When the term ends, you get back your principal plus the accumulated interest. CDs with longer terms generally yield the highest interest rates.

If you withdraw money from a CD before its expiration, which is known as the maturity date, you typically must pay a penalty.

However, if you withdraw money from a CD before its expiration, which is known as the maturity date, you typically must pay a penalty. The penalty amount is usually calculated as an amount of interest, depending on the term. For example, a one-year CD might charge the eqivalent of three months' worth of interest if you dip into it. So, it's crucial to be sure that you won't need to withdraw any amount before the maturity date. 

What are the different types of CDs? 

A CD with a fixed term and interest rate is called a traditional CD, which is the most common type. However, depending on where you buy a CD, other types may be available, such as:

  • Variable, which pay an interest rate based on an index such as the Treasury bill rate or the prime rate
  • Zero-coupon, which pay interest only at the end of the term and don't allow the option to withdraw interest 
  • Add-ons, which allow you to make additional deposits to a fixed- or variable-rate CD
  • Callable, which give the bank the right to "call" or buy back a CD after an initial period and before the end of the term
  • Liquid or no-penalty, which allow you to withdraw a portion of your money without paying a penalty
  • Bump-up, which give you a fixed interest rate with the option to increase the rate one time during the term of the CD to take advantage of rising interest rates
  • Step-up or step-down, which give you a fixed interest rate for a set period and then automatically increase or decrease to a predetermined rate
  • Jumbo, which require a deposit of at least $100,000 and typically offer a higher rate of interest

How to find high-yield CDs

As I mentioned, in general, the longer a CD term, the more interest you earn. For example, Bankrate.com shows that First Internet Bank of Indiana has a five-year CD paying 1.77% APY, and Ally Bank has a one-year CD that pays 1.35% APY. 

If you put $10,000 in the one-year CD and didn't withdraw any interest, you'd make $135 at the end of the term. To figure returns on CDs with terms longer than one year, you can use Bankrate's CD calculator.

Like with high-yield savings accounts, you can find the highest paying CDs at online banks, credit unions, and investment firms. They typically have lower overhead, which means they can pass the savings along to customers in the form of higher interest rates. But local community banks and credit unions can also offer competitive CD rates when they're trying to attract more deposits.

What is CD laddering?

A common strategy to maximize earnings from multiple CDs is called laddering. You buy CDs with different maturity dates and annual yields. Each one represents a rung on a CD ladder that goes from shorter to longer terms. 

Laddering CDs protects you against missing out on higher returns if interest rates rise; you earn more money and get greater flexibility.

Imagine that you bought a $100,000 traditional, five-year CD paying 1.75%. Now, think how bummed you'd be if the interest rate for a five-year CD went up to 2.75% the following year. You'd miss out on earning more interest because you locked up your money at 1.75% for five years and can't make a withdrawal without paying a penalty.

With laddering, you might choose to buy five CDs with your $100,000, instead of just one. For instance, you could buy a $20,000 one-year CD, a $20,000 two-year CD, a $20,000 three-year CD, and so on, up to a five-year CD. After one year, when the first CD reaches maturity, you can use all or a portion of the money to purchase another five-year CD. So, as your shortest CD matures, you use it to buy a longer-term CD that presumably has a higher interest rate.

Laddering CDs protects you against missing out on higher returns if interest rates rise; you earn more money and get greater flexibility. As each CD matures, you have the option to renew it at the current rate, or to use your money for something completely different. Use a CD ladder calculator to see how you could benefit from using this strategy.

When should you buy a CD?

Now that you know more about CDs let's get back to Anna's question about whether she should buy one. I don't recommend putting any amount of your emergency fund in a CD because it'll cost you if you need to make a withdrawal.

However, if you have more cash on hand than you need, buying one or more CDs may make sense. First, set a target emergency fund amount, such as the equivalent of three- or six months ' worth of your living expenses. How much you need depends on your work and family situation. For instance, if you're the only breadwinner in a large family, you might need to save 12-months of living expenses.

If Anna has more than a healthy amount of savings for her situation, putting the excess in a short-term CD might be a good option. She could earmark it for something specific, such as a vacation or the house that she plans to buy after the CD maturity date. I recommend that Anna make accumulating a downpayment a separate goal from building and maintaining her emergency fund. 

Balancing risk and reward is something savers and investors must manage, especially when interest rates are at record lows. CDs don't offer much return on your money, but they do give you a guaranteed return.

If you're ready to buy a CD, compare rates to high-yield savings and money market deposit accounts. You might find that rates are close to or even lower than some savings products. In that case, stick to high-yield savings so you don't sacrifice any liquidity. Remember that the point of having an emergency fund is to have the ability to tap it the moment you need it.

Balancing risk and reward is something savers and investors must manage, especially when interest rates are at record lows. CDs don't offer much return on your money, but they do give you a guaranteed return. 

To sum up, buy a CD only when you have fully funded an emergency fund and still have a large amount of cash that you want to keep safe. Use one or more CDs if you can earn more interest than with a savings or a money market deposit account. This might be your situation if you're retired or nearing retirement or you have a specific goal that you want to reach after a CD matures, such as buying a home, starting a business, or making any other large purchase.

About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a trusted and frequent source for the national media. Her book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show. 

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