How to save with CDs #CashNews.co

A certificate of deposit, known as a CD for short, can be a useful tool when you’re trying to reach different types of savings goals. Whether you’re looking for low-risk ways to grow your cash or you want to diversify existing investments, CDs can be worth considering.

The following guide will help you discover how certificates of deposit work, along with the benefits and drawbacks these savings vehicles have to offer. You’ll also learn about the different types of CDs and several strategies you can use to enhance your savings efforts if you decide that CDs are a good fit for you.

You open a traditional CD by depositing a lump sum with a bank or credit union. (Note: At credit unions, CDs are known as share certificates.) The funds you deposit earn a fixed percentage of interest for a predetermined period of time.

Depending on the terms of your account, the bank or credit union may deposit the interest you earn back into your CD or pay those earnings out to you at regular intervals (e.g., once a month or once a year). Yet unlike standard savings accounts, you must typically agree not to withdraw any funds from your CD until it reaches maturity. At that point, you can withdraw the funds or roll them into a new CD.

The average savings account featured an annual percentage yield, or APY, of around 0.4% as of May 15, 2023, according to the Federal Deposit Insurance Corporation (FDIC). Average rates for 1-year CDs, by comparison, were close to 1.6%. And some of the best CD rates are over three times higher than the national average. Therefore, it’s essential to shop around for the best CD rates to maximize the earning potential on your savings.

Regardless of the interest rate you lock in, if you try to withdraw your cash before a CD reaches maturity, you could face an early withdrawal penalty. These penalties can cut into or wipe out the interest you earn on your savings, so it’s important to plan ahead and only deposit as much money into CDs as you feel comfortable leaving untouched for a predetermined period.

• Unlike the stock market, CDs offer guaranteed returns making them a low-risk way to grow your savings.

• CDs offer higher returns on average compared with other deposit accounts.

• When you open CDs from federally insured banks or credit unions, your deposits are insured for up to $250,000 (per financial institution).

• Opening CDs may discourage the temptation to tap into your savings early since unplanned withdrawals usually result in a penalty.

• If you need to access your cash before a CD’s maturity date, you’ll typically have to pay an early withdrawal penalty to do so.

• The interest rates on CDs — especially long-term CDs — might struggle to keep up with rising inflation over time.

• Although CDs are a safer savings option, they feature lower historical returns compared with higher-risk investments (by comparison) like mutual funds and stocks.

Whether you’re saving for a down payment, home improvements, or another short- to mid-term financial goal, when you invest in a CD you might reach your objective faster. Yet because CDs lock away your money for a period of time, using them requires more planning than storing your cash in more liquid savings accounts.

Below are three common CD savings strategies to consider.

• CD ladder: CD laddering is a savings strategy that involves opening multiple CDs with staggered maturity dates. By spacing out the dates at which your CDs mature, the goal is to maintain access to a portion of your savings at periodic intervals while still earning higher interest rates than you would in a more liquid type of deposit account.

Here’s an example of a CD ladder. Imagine you open three certificates of deposit — a 6-month CD, a 12-month CD, and an 18-month CD — and you split your savings into even amounts among each account. This setup would allow you to access or roll over the cash in your CDs at six-month intervals.

When the first CD in your ladder matures, you could open a new 2-year CD with that chunk of your savings (assuming you don’t need to use the money for another purpose). Opening a new CD would continue the cycle — permitting you access to a portion of your savings every six months while also enjoying the higher interest rates that CDs have to offer.

• CD barbell: A CD barbell is another financial tactic that involves dividing your savings between multiple CDs with different maturity dates. However, with this approach, you choose long-term and short-term accounts with no medium-term CD options.

The idea of the barbell strategy is to maintain access to a portion of your cash savings by investing some of your funds in short-term CDs. With the remainder of your savings, however, the goal is to earn the highest interest rates possible (which may be available with long-term CDs).

Yet there are two potential flaws with this savings strategy. First, long-term CDs don’t always offer the highest APYs available. And if you lock in a rate on a long-term CD in an environment where rates are on the rise (as they have been in recent months), you might miss out on the opportunity to earn higher APYs in the future.

Here’s an example of how the bullet CD strategy works. Imagine you’re saving money for a down payment on a house that you plan to purchase in five years. To start the savings process, you deposit a lump sum into a five-year CD. The following year, you have more cash available, so you decide to open a four-year CD, which will mature around the same time as the original account you opened.

You repeat the process each year with additional lump sum deposits into new CDs (e.g., a three-year CD, a two-year CD, a one-year CD, etc.). After your CDs mature, you apply all the funds toward your financial objective including, of course, any interest your cash earns along the way.

Once you understand how CDs work and the most common CD savings strategies, you can review which types of CDs might work best for you. In addition to traditional certificates of deposit, there are several options to consider.

• Bump-up CDs: With a bump-up CD, you can request an increase in your annual percentage yield (APY) if interest rates rise at your financial institution before your CD matures. In general, you can only request one rate increase per term with a bump-up CD, but some banks may allow for multiple requests for long-term CDs. The initial APYs on bump-up CDs are often lower compared to other types of CDs as well.

• Step-up CDs: Step-up CDs are similar to bump-up CDs. However, with a step-up CD, your financial institution will automatically increase your APY at predetermined intervals throughout your term.

• Callable CDs: A callable CD is a type of savings account where the bank has the right to terminate the CD before its maturity date arrives. In exchange for this risk, a callable CD might pay a higher interest rate compared with traditional certificates of deposit. But if interest rates decline, the financial institution could call the CD early so it no longer has to pay the higher APY.

• No-penalty CDs: With a no-penalty CD (sometimes called a liquid CD), you have the option to take funds out of your account before the maturity date without paying an early withdrawal penalty. In general, interest rates are lower on no-penalty CDs compared to traditional certificates of deposit. But since there’s no fee for early withdrawals, it might be easy to switch your cash over to a CD with a higher APY if interest rates rise (depending on the terms of the account).

• Bull CDs: The interest you earn on bull CDs is tied to a specific market index. When (and if) that market index rises, a bull CD will pay you a predetermined percentage in the form of interest as a return on your investment. Most bull CDs also feature a guaranteed minimum rate of return.

• Bear CDs: Bear CDs are also tied to a specific market index, but the potential returns you may earn from a bear CD are based on shares of any market declines that occur. If the index decreases, the CD’s interest rate climbs, and the opposite is true as well.

• Jumbo CDs: With a jumbo CD, a bank tends to require a larger opening deposit than it would for a traditional CD. It is not unusual for banks to require $100,000 or more to open jumbo CDs, but minimum deposit requirements can vary.

• Uninsured CDs: Uninsured CDs are not covered by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Because you are assuming more risk when you open these types of deposit accounts, uninsured CDs might feature higher APYs compared with traditional certificates of deposit.

• Variable-rate CDs: When you open a variable-rate CD, the interest rate can fluctuate up and down with the market rather than remain fixed until your maturity date arrives. If interest rates increase, you could earn more on your savings with a variable-rate CD. But there’s a risk your APY could drop if rates decline.

• Zero coupon CDs: With zero coupon CDs, the financial institution that issues the account doesn’t pay you interest during its term. Rather, you purchase the CD at a discount. When the CD matures at the end of its term, the bank pays you its full face value. For example, you might pay $4,000 for a five-year zero coupon CD with a face value of $5,000. That arrangement would be equivalent to an APY of 5% — $200 in interest each year for five years.

CDs aren’t a one-size-fits-all solution for every financial situation. But they can be a solid, low-risk savings option if you’re seeking higher returns than traditional savings accounts may offer.

If you decide to incorporate CDs into your overall savings strategy, it’s important to shop around and compare your options. There are many CDs to choose from, and some banks offer higher interest rates than others. Once you choose the best CD for you, consider adding in some of the strategies above to supercharge your savings and potentially reach your financial goals even faster.