Are CDs Worth It? | TIME Stamped


Certificates of deposit (CDs) allow you to set aside money for a specific term, earning interest until it matures. Banks and credit unions can offer CDs, but they don’t always pay the same rates.

So, are CDs worth it as a savings option? They could be if you have a specific goal in mind and you’re able to find the best CD rates.

CD rates are on the rise thanks to several rate hikes instituted by the Federal Reserve in an attempt to quell high inflation. Numerous banks are offering CDs in the 5% range, while some are paying up to 7% for CD specials. However, it’s important to remember that CD rates can change in relation to what’s happening with the economy and federal interest rate policy.

Here’s what to consider when deciding whether CDs might be right for you.

Benefits and drawbacks of CDs

No savings option is perfect and while there are plenty of advantages associated with CDs, there are some potential downsides as well. Knowing what’s good and bad about CDs is helpful, especially if you’re new to this type of savings vehicle.

CD benefits

Before diving into the benefits of CDs, here’s a little more background info on how they work.

When you deposit money into a CD, you’re agreeing to leave the money where it is for a set maturity term. That maturity term might last anywhere from 30 days to 10 years, depending on where you’ve opened the CD.

While your money is in the CD, the bank pays interest to you. Once the CD reaches the end of its term or matures, you can withdraw your original deposit and the interest earned, or roll it all over to a new CD.

Now, as for the benefits of CDs, here are some of the best reasons to consider using them to save:

  • Fixed rates. CDs typically offer a fixed interest rate, which you’ll earn for the entirety of the maturity term. That makes it easy to estimate how much your money will grow as you wait for your CD to mature.
  • Higher returns. A CD may allow you to earn more interest compared to a traditional savings account, depending on where you decide to open one. As long as you don’t need the money in a CD before it matures, you could earn a decent amount of interest this way, especially when rates are climbing.
  • Safety. CDs are one of the safest options for growing your savings, while enjoying some predictable returns. As long as you’re saving in a Federal Deposit Insurance Corporation (FDIC)-insured bank, your money is protected up to $250,000 and again, interest is guaranteed.
  • Flexibility. CD accounts can come in a wide range of terms, allowing you to select the options that best fit your goals. And assuming you have enough money to do so, you could open more than one CD account with different terms.

Saving in a CD can also allow for some variety, as there are different types of CDs you can choose from. In addition to the traditional CD option, you might be able to open a raise-your-rate or bump-rate CD, add-on CD, or a no-penalty CD.

Raise-your-rate and bump-rate CDs allow you to increase your CD rate once (or twice) during the CD term. That’s a plus if rates rise after you initially opened your account and don’t want to miss out on higher rates. Add-on CDs, meanwhile, allow you to make monthly deposits to your account after the initial opening, something traditional CDs usually don’t permit.

No-penalty CDs let you withdraw money from your account before it matures, without a penalty. Early withdrawal penalties are one of the CD drawbacks we’ll cover in the next section.

CD drawbacks

As mentioned, there are some things that could make you think twice about saving in CDs. Here are some of the most important disadvantages to consider:

  • Access. Unless you’re getting a no-penalty CD, you’re expected to leave your money where it is when you open a new CD account. It’s important to understand what CD term works best for your goals so that you don’t choose one that’s too short or too long.
  • Penalties. Banks can charge an early withdrawal penalty for taking money out of a CD account before it matures. Depending on the bank, you might pay a flat fee or a percentage of the interest earned. As a general rule, the longer the CD term, the bigger the penalty ends up being.
  • Rates. When interest rates are on the rise, banks can offer higher rates to savers to encourage them to keep their money on deposit. But if the economy shifts, CD rates can plummet, making them much less valuable as a savings tool.
  • Lower returns than investing. While you might be able to earn a decent amount of interest with high-yield CDs, you could get better returns for your money by investing in the stock market. The trade-off, however, is that investing can be a riskier option and there’s a greater possibility of losing money if your investments don’t pay off.

As you’re evaluating CD options, it helps to know how to compare them. The interest rate and annual percentage yield (APY) are a good place to start, but it’s also helpful to look at the CD terms that are available, fees, and minimum opening deposit requirements.

Some banks may allow you to open a CD account with $0 initially, then make your first deposit within five to seven business days. Others may require you to deposit $500, $1,000, or $5,000 or more right from the start. Again, fees can add up if you need to take money out early but you could get around penalties by building a CD ladder.

CD laddering involves buying multiple CDs with varying maturity terms. The idea is that a maturity date should always be on the horizon in case you need to make a withdrawal. That can allow you to avoid early withdrawal penalties and potentially cash in on higher rates if you’re able to move your savings into a new CD with a higher APY.

Laddering CDs has some advantages, but keep in mind that you’ll need to be able to meet the minimum deposit requirement for each “rung” you establish.

When are CDs a good investment?

Saving money in a CD could make sense if you know that you won’t need those funds before the CD term ends and you’re able to find competitive rates. Of course, it’s helpful to consider other savings and investment options when determining the best way to put your money to work.

For example, you might decide to open a high-yield savings account or money market account instead. Savings accounts and money market accounts allow you to deposit money and they can earn interest, but there are two key differences. (1) These accounts let you withdraw money, typically up to six times per month, with no penalty fee. And (2) interest rates aren’t fixed. If the economy changes, the interest these accounts pay could diminish. That won’t happen with a CD.

In terms of how the rates compare, it typically depends on where you’re planning to open a savings account, money market account, or CD account. It’s possible to find CDs that pay higher rates than savings or money market accounts, but again, you have to remember that your money is effectively locked in once you deposit it.

If you’re looking for the highest returns for your money, then you might consider investing it instead of saving it. For instance, you could open a brokerage account and buy stocks, bonds, exchange-traded funds (ETFs), or mutual funds. even cryptocurrency. The most important things to consider when investing are your personal risk tolerance and goals.

As a general rule, greater risk usually means greater rewards. Opting for safer investments, meanwhile, could make it less likely that you’ll lose money. And bank CDs are protected by the FDIC, and credit union ones by the NCUA.

TIME Stamp: CDs can be worth it, but it pays to do your research

Putting money into CDs when rates are high could help you earn a decent chunk of change on your savings. Comparing CD rates and terms from different banks and credit unions can give you an idea of what’s available and how much of a return you could get for your money. It’s also a good idea to keep an eye on how interest rates are moving and how that might affect CD rates.

Frequently asked questions (FAQs)

Do CDs make you money?

CDs can make you money if you’re earning interest on the money you deposit. The higher the APY, the larger the deposit, and often the longer the CD term is, the more money you could earn. Saving in CDs is just one way to generate passive income, since your money is working for you and not the other way around.

Is CD interest taxable?

Interest on CD accounts and other savings accounts is considered to be taxable income by the IRS. Your bank should furnish you with a form showing how much interest you earned during the year, which you’ll need to report on your tax return.

Which bank offers the best CD rates?

CD rates can vary from bank to bank but the best options can usually be found online. Online banks often pay higher CD rates to savers than traditional banks, largely owing to their overhead costs. You can also find special CDs with above-average rates offered at credit unions, though you’ll typically need to be able to meet membership requirements in order to join and open an account.

Source link

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button