If you’ve ever looked into saving money, you probably know that there are many options out there besides your standard savings account. Some of these options sound lucrative because they offer higher interest rates. Who doesn’t want to earn more cash just by depositing some money into an account?
You may be tempted to invest in a CD because of the higher interest rate they offer, but before you do, make sure you know what you’re committing to.
What is a CD?
A CD, or certificate of deposit, is a type of savings account with a fixed interest rate. They are federally insured like a regular savings account, but they usually offer higher interest rates than you can get from even a high-yield savings account.
It’s important to note that CDs require that you leave your money in them for a certain length of time. Early withdrawal can result in penalties. These penalties are usually based upon the amount of interest you’ve earned or would have earned if you hadn’t withdrawn the money.
What is the purpose of saving your money?
One of the most important questions you need to ask yourself is, what is the purpose of saving your money? Knowing why you are saving your money can help you decide if a savings account or CD is right for you. Are you saving for a short-term goal? Are you hoping to save for a big expense? Are you just looking for a safe place to park your cash long term?
For short-term savings goals, a savings account may be your better choice. You can withdraw several times a month, have access to your money the same day, and have no penalties when you make a withdrawal.
How soon will you need your money?
The benefits of the high-interest rate CDs can be significantly reduced if you withdraw early. It’s best to leave the money until the term is up. Terms can range from 21 days to 10 years, so you have a wide variety of options. Longer-term CDs usually offer higher rates, but if you have to withdraw early, those benefits might be erased.
Think about the timeline of what you’re saving for, and plan your term accordingly. If you know you’ll need the money sooner, or need to access it frequently, then a savings account is a better choice.
Do you have access to cash in an emergency?
Where will you get money to cover emergencies? Can you cover 3 to 6 months of expenses without accessing your CD? We’ve talked about the importance of saving for an emergency fund. If you’re looking for a place to stash your emergency fund, a CD is not the place. Even though the interest rates may look great on paper, you want to be able to access your emergency fund as soon as possible, and without penalties, if there is an emergency.
Interest rate fluctuation
Another thing to consider before committing to a CD is that an interest rate that sounds good now may not be as competitive in a year. Making a long-term commitment to a fixed-rate CD could mean that you miss out on future gains if the market improves.
One alternative is the variable-rate CD. These CDs still require a fixed term, but the interest rate may vary depending on factors such as the consumer price index or treasury bills. If you buy a CD while interest rates are low, your interest rate will most likely improve when the market improves, giving you an advantage over a fixed-rate CD.
No-penalty CDs seemingly offer the best of both worlds: they pay a higher interest rate than savings accounts, but don’t penalize you for withdrawing your funds before the term is up. This means you can access your funds in an emergency, or reinvest funds into a higher interest rate CD when rates improve.
However, be sure to read the fine print: some still don’t allow withdrawals until a certain amount of time has passed. Additionally, the interest rates they offer will be lower than fixed-rate CDs.
A CD is a safe investment. You won’t lose money, which can make it an attractive choice for those with a low risk tolerance for investments. Before investing in a CD, make sure you understand the term, interest rate, and the withdrawal penalties. If you can’t commit to the term that the CD is asking, it’s best to use a savings account rather than a CD. And always make sure that you have at least 3 to 6 months of emergency fund savings that you can access quickly if you need to!