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The year 2022 has not been kind to our wallets. But amid rising prices (ie, inflation) there is at least one perk: Savings account rates have increased, including on certificates of deposit.
Some CDs currently have returns in excess of 3%, but like any bank account, they don’t work for every financial situation. Let’s see if CDs make sense for you.
Quick definition: CDs hold money, not music
If you came to this article thinking of CD as in CD for music, I apologize — but good luck with your old school music collection.
In banking, a CD refers to a certificate of deposit, which is a type of savings account that has a fixed term and a fixed interest rate. You add money, you wait for the term of the CD — usually three months to five years — to complete, and you get your money back with interest.
Banks and credit unions, which are the non-profit counterparts of banks, are the main places to open CDs. Credit unions usually call CDs “share certificates”. Brokerages also offer CDs, but the process is more complicated and requires an investment account.
More: Surprise! CDs are back in vogue with Treasurys and I-bonds as safe havens for your money
CDs: The good, the bad, the punishment
Here’s the biggest reason to consider CDs: They can offer the highest guaranteed returns to a bank account. And current CD rates are some of the highest in a decade, based on NerdWallet’s analysis of Fed data and its own data. When the Federal Reserve raises its rate, as it often did in 2022, banks tend to raise their savings and CD yields.
However, online-only institutions have the best rates. At the time of writing, you can find rates for one-year CDs above 2.3% APR, three-year CDs above 2.7% APY and five-year CDs above 3% APY. National average CD rates, by contrast, are below 0.70%, which is still better than the national average of 0.13% on regular savings accounts.
Take this scenario: Put $10,000 into a CD at 3% for a five-year term, and you’ll earn about $1,600 in interest. Try the same amount and the same time frame but in a savings account with a rate of 0.13%, and you will earn about $65. I want to choose the first option.
Unlike some checking or savings accounts, CDs have no monthly fees or minimum balance requirements other than a minimum amount to open. High yield CDs have minimums between $0 and $10,000.
CDs are like a bank account with a lockbox. In exchange for high rates, you give up access to funds. The first time you add money is almost the only time you add money, so you have to be okay with transferring a good amount of money into an account beforehand. Your money is then locked in for the CD term you choose.
If you need to cash out a CD soon, however, it could go wrong. You must withdraw all the money in one transaction and almost always pay a penalty that costs several months to a year’s worth of interest that you earned – or would have earned. A bank can dip into your principal amount to cover a penalty. Unlike other bank accounts, however, CDs only have this one potential cost, and you can avoid it by waiting for a CD to mature.
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When would CDs work best for me?
CDs have more specific use cases than your everyday checking and savings accounts. Ask yourself any of these questions before you decide to open one.
1. Do I need more distance from some savings?
Say you run into an inheritance or other type of windfall; or you have accumulated savings for years; or, you are like my parents who – when I was growing up – made some savings in a share certificate to keep it off. Whatever the reason, a CD is built to keep you from being tempted to spend those funds.
2. Do I have savings for a large purchase?
If you have interest planned for a car or a down payment on a house in the next few years, a CD helps you put the funds aside until you’re ready.
3. Do I want to protect some wealth outside of investments?
CDs provide short-term safety, not long-term growth. Funds are federally insured like they are in other bank accounts, which means your funds are returned to you even if a bank goes bankrupt. There is no risk that the value of CDs will change like in the stock market.
CDs are “in the middle between emergency savings and investment,” says Derek Brainard, national director of financial education at the AccessLex Institute, a financial literacy nonprofit.
Essentially, CDs are cash reserves for short-term goals. Emergency savings should be immediately accessible if needed, while investing – for example in stocks or bonds – is to accumulate wealth over the long term, explains Brainard.
Visit MarketWatch’s How to invest page
What if CDs aren’t right for me?
It may be hard to think about high CD rates, but you may realize that losing access to funds is not worth it. You can still take advantage of the rising rate environment by opening a high yield savings account. Like high-yield CDs, these accounts are primarily available at online banks and credit unions. Many currently have rates close to 2% APY, and you can add or remove money at any time.
Also read: 3 ways retirees can make the most of their money in an unpredictable market
I want a CD, but what if CD rates go up?
A fixed-rate CD can be a double-edged sword: It provides guaranteed returns, but if rates rise, you lose out on higher rates after locking in your own. And rates have been increasing recently.
“If you believe the rate environment will continue to rise, one strategy to offset that risk is certification [or CD] ladder,” says CJ Pointkowski, assistant vice president of savings products at Navy Federal Credit Union.
Creating a ladder CD, or CD ladder, is more than opening multiple CDs of different terms — usually short, medium and long term. A common ladder consists of one- to five-year CDs where five CDs mature at staggered intervals, such as every year for the next half century. When each CD ends, you can reinvest in a new five-year CD to take advantage of higher rates in the future—or you can withdraw the money.
If juggling multiple CDs is a challenge, another strategy is to open a CD without penalty. This less common type of CD allows free early withdrawal at any point after the first few days, removing any barriers to switching to a higher rate CD later. But rates alone shouldn’t guide your decision to open a CD.
“At the end of the day, a CD will be the right tool or not, regardless of what’s happening in the interest rate environment,” says Brainard.
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Spencer Tierney writes for NerdWallet. Email: firstname.lastname@example.org. Twitter: @SpencerNerd.