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Certificates of deposit (CDs) are deposit accounts that offer you a guaranteed return over a fixed period, such as six months or as long as five or 10 years. Instead of investing all of your money in one CD, you can invest in multiple CD accounts through different strategies like the CD barbell.
A CD barbell is where you invest in a short-term CD and long-term CD to increase your returns without locking all of your money away for an extended period. Read on to learn what a CD barbell is, how it compares to a CD ladder and when it makes sense.
What Is a CD Barbell Strategy?
The CD barbell strategy is where you split up your deposit into separate CD accounts: One amount goes into a short-term CD, and the other goes into a long-term CD. The two CD accounts make up two "weights" on a barbell, hence the name.
The purpose of a CD barbell is to give you the best of both worlds when saving and investing. In general, longer-term CDs offer a higher annual percentage yield (APY) because you loan your money to the bank for a longer period, and the reward for this is a better rate.
However, a drawback of long-term CDs is that your money is locked away for a longer period, and you could face penalties if you make an early withdrawal unless you have a no-penalty CD. A second drawback of long-term CDs is that you risk missing out on better interest rates if rates tick upward before your CD matures.
Putting a portion of your cash into a short-term CD with the barbell CD strategy gives you access to some of your money earlier if you need it. Plus, if market interest rates rise, you can reinvest your short-term CD into a higher-interest CD to maximize earnings.
Barbell CD Strategy Example
Right now, APYs on many short-term CDs are higher than on long-term CDs, which presents a unique opportunity for short-term savers. This anomaly may be due to uncertainty among economists and financial institutions on where market rates are headed next.
When long-term CDs provide higher interest rates—which is what's most often the case—here's an example of how the CD barbell might play out.
| Short-Term vs. Long-Term CDs | ||
|---|---|---|
| Short-Term CD | Long-Term CD | |
| Amount deposited | $3,000 | $3,000 |
| Term length | 3 months | 5 years |
| Annual percentage yield (APY) | 4% APY | 5% APY |
| Interest earned | $29.56 | $828.84 |
| Total interest earned over 3 years | $858.40 | |
Barbell CD Strategy vs. CD Ladder
Both the CD barbell and CD ladder are investment approaches where you open multiple CD accounts—but the difference is the number of accounts in the strategy.
With a CD ladder, you break up your money across many CDs and stagger terms. For example, you could have five CDs that mature every year, or five CDs that mature at three months, six months, 12 months, two years and five years. CD ladders make your money continuously available on an ongoing schedule, and you can choose to reinvest cash when CDs mature or withdraw to meet financial goals, like paying for a trip, child care or school tuition.
In comparison, a barbell CD is just two CDs, one short-term and one long-term, with no CDs in between. A CD barbell offers fewer accounts to manage, but it can also mean you miss out on interest earnings on the middle rungs of the ladder.
Pros and Cons of a CD Barbell Strategy
There are both pros and cons of using a CD barbell. Before trying the strategy, here's what you need to know:
Pros
- Guaranteed interest: CDs typically offer a fixed interest rate for a fixed term so account earnings are predictable.
- A portion of your money is accessible: A short-term CD makes some of your money available in a shorter time frame, reducing the risk of making an early withdrawal. The short-term maturity date also gives you the flexibility to draw funds and secure a better interest rate if CD rates increase.
- Money backed by deposit insurance: When you invest in CDs insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA), up to $250,000 per depositor, per account ownership category is guaranteed by the government should the financial institution fail.
Cons
- Early termination penalties: If you need to draw from any of your CDs early, you could face a penalty that equals a portion of the interest earned.
- Earnings limitations: Investing in the stock market could provide a greater return than CDs if you have a long time horizon, such as 10 or 20 years. Speaking with a financial advisor could help you determine the best way to manage your money.
When Should I Use a Certificate of Deposit (CD) Strategy?
CD investment strategies make sense when you're looking for a low-risk place to set aside money you don't need for emergencies or bills. CD barbells specifically can be beneficial when you have money to put toward a long-term goal and another sum for a short-term goal.
For example, say you have a lump sum of money you'd like to save for different goals. Part of it you want to save for a summer vacation, and the other part you want to use to buy a car when your teen turns 16 in three years. A short-term CD could offer you a guaranteed rate of interest on your summer vacation fund when it matures in three months, and your long-term CD could provide a guaranteed rate of interest when it matures near your teen's 16th birthday.
Alternatives to a CD Barbell Strategy
Below are different savings strategies you could consider besides the CD barbell strategy:
- CD ladder: A CD ladder is a good ongoing savings strategy where you open CD accounts that mature on a staggered basis. When CD terms end, you can roll them into new ones and keep the ladder going, continually reinvesting your money to take advantage of compounding interest, or withdraw your money for other purposes.
- CD target: The CD target strategy is when you open CDs with terms that meet a specific date or target. For example, if you want to buy a home in five years, you could place $15,000 in a five-year CD term. If you save up another $5,000 by the end of this year, you could place the $5,000 into a separate four-year CD. Each CD you open has a maturity date that aligns with your goal's deadline.
- High-yield savings accounts: High-yield savings accounts off a higher-than-average yield compared with typical savings accounts, and you can deposit or draw money from them on a regular basis. While the APY on high-yield savings accounts can change (and be lower than CD accounts), they could be a better place to put emergency savings and cash you need for other near-term financial responsibilities.
The Bottom Line
When your savings earns a very limited amount per year in a traditional savings account, investing in CDs can make your money work harder for you. Employing a strategy like the CD barbell is a way to take advantage of long-term CD rates while adding a short-term CD to the mix so you have some financial wiggle room. Shopping around to compare rates for different CD terms can help you find the right CDs to add to your portfolio.