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Certificates of deposit (CDs) are a unique type of savings account that offers a fixed interest rate over a specific term, typically ranging from three months to five years. CDs are particularly attractive to savers because they offer a guaranteed return that is often substantially greater than a traditional savings account.
On the other hand, most savers' main concerns with CDs are not being able to access their money during the term and the possibility of missing out on higher annual percentage yields (APYs) if they rise during the CD's term. Fortunately, a little bit of planning can put these concerns to rest.
Here are six strategies for saving with CDs to help you maximize interest rates, minimize risks and achieve your savings goals.
1. Build a CD Ladder
CD laddering is a strategy that allows you regular access to your funds with the potential to take advantage of higher long-term interest rates. You can build a CD ladder by buying multiple CDs with staggered maturity dates of, say, six months, one year, two years and three years.
This way, your CDs will mature on a regular cadence to give you a chance to withdraw your money on schedule without early withdrawal penalties. Alternatively, you could reinvest your funds in the same fund or another one to continue saving and earning interest. If rates rise, you can always reinvest expiring short-term CD funds into a new higher-earning CD. But if rates fall, you can have peace of mind knowing your long-term rates are still earning the higher rate.
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2. Employ a CD Barbell Strategy
While the CD ladder includes terms of any length, the CD barbell strategy only uses short- and long-term CDs without any midrange terms. With a CD barbell, you might split an investment between a six-month CD and a five-year CD. This strategy may be an excellent option if you're trying to achieve both short-term and long-term savings goals. For example, you could use the short-term end of the barbell for an upcoming vacation and the long-term one for your child's college education.
It's wise to weigh the potential increase in APY that comes with a longer-term CD against the early withdrawal penalty you could incur if you suddenly need to access your funds. Consider your financial needs and time frame for needing your funds before committing to a longer-term CD.
3. Use a CD Bullet Strategy to Save for a Goal
This lesser-known CD investment strategy focuses on purchasing CDs of varying lengths that all mature around the same time. For example, if you plan on buying a home in five years, you could start saving for the down payment by opening a five-year CD. A year from now, you could build on your savings by opening a four-year CD, timed to mature at the same time as the first CD. You can repeat this process as much as you like to create a substantial sum you can withdraw at the same time when you are ready to buy a home.
While the CD bullet strategy is an effective method to reach your savings goals, it does have its drawbacks. For one, you'll have limited access to your funds until the CDs mature, so you should be reasonably certain you won't need to access the money before then. Also, interest rates may decline between your first CD investment and subsequent ones, in which case you may earn a better return with a single long-term CD that expires at your target date.
4. Consider Bump-Up and Step-Up CDs
If your primary concern is that you'll miss out on higher APYs while your money is locked in a CD, consider opening a bump-up or step-up CD, both of which allow you to take advantage of rising rates during the CD's term.
With a bump-up CD, you can typically opt for a higher interest rate your bank currently offers once or twice during the CD's term if their rates rise. By contrast, a step-up CD automatically increases your interest rate at preset times, such as annually or bi-annually. Keep in mind, however, both types of CDs may begin with a lower interest rate than you'd receive with a traditional fixed-rate CD with the same term.
Both CDs can help you meet your savings goals by providing a higher interest rate, but choosing one may come down to how involved you want to be. Bump-up CDs give you some control over when to take advantage of a rate hike, but you must keep track of your bank's current APYs so you can request it at the right time. Meanwhile, step-up CDs are more "set it and forget it," with predetermined rate boosts that happen automatically.
5. Understand Early Withdrawal Fees
Early withdrawal fees on CDs can significantly cut into your earnings. In some cases, you could even end up with less money than you put in, so it's good to know your bank's early withdrawal rules before you open an account and, certainly, before you withdraw funds. Choosing a CD with less costly fees can help you minimize loss if you need to cash out of your CD early.
Federal law doesn't mandate a maximum fee, so you'll find varying penalties from bank to bank. Generally, early withdrawal fees come in the form of lost interest. For example, American Express imposes early withdrawal penalties of 270 days of interest for a one-year CD and 540 days of interest for a five-year CD.
6. Avoid Penalties With No-Penalty CDs and Brokered CDs
A no-penalty CD allows you to withdraw funds from your CD before its term ends without incurring any fees. While these CDs may come with lower interest rates than traditional ones, they can help you avoid losing interest if you need your funds early. As such, no-penalty CDs are an option worth considering if you want higher earnings than a traditional savings account with the flexibility to access your money in a pinch.
Brokered CDs are another type of CD that allows you to sidestep the early withdrawal penalty by selling your CD on the secondary market at the current rates. These CDs, which are typically offered by brokerage firms, often offer higher interest rates and longer terms than those offered by banks. As with any savings or investment product, it's critical to weigh the benefits and downsides before making a decision.
The Bottom Line
Any CD strategy you choose should align with your savings goals and overall financial plan. By planning your CD investments wisely, you can earn higher APYs on your savings than a standard savings account and minimize—or even eliminate—the risk of an early withdrawal fee.
High-yield savings accounts (HYSAs) are another option for a solid return on your savings with the flexibility to access your funds at any time. Many online banks offer HYSAs with APYs that are much higher than what you'd get with a traditional savings account.