Early withdrawal penalties on CDs can be onerous, not only can they wipe out all of your interest but they can even reach into the investment principal, which clearly works against all the logic of CD investing.
Nonetheless, some investors like to game the system and buy a longer-term CD for the higher yield and then cash it in early. With some simple math and wise choosing when it comes to buying the CD, they can end up with more money after the penalty than they could have received in a shorter-term investment.
But should bailing out early be part of your CD investment strategy? Not necessarily.
Some investment advisers don't condone the practice because its inefficient to invest in CDs with a longer maturity than you desire.
"If we were going to invest in CDs, it would be with the intention of holding it to maturity because we think the reason to own a CD is to have a specified time frame in mind and stick to it," says Christopher Davis, director of communications and retirement services at HFM Wealth Management in Hartford, Conn.
"If we thought we weren't going to hold it to maturing, we might look at individual bonds, as it might be more advantageous," he says.
Also, there's a better option than simply taking the penalty hit, particularly for investors worried about interest rate risks -- CD ladder.
For instance, if an investor believes that interest rates will rise soon but doesn't want to limit himself to the paltry yields on some 6-month CDs, a short ladder can spread out the interest rate risk.
"The reality is that a lot of it is out of our control if there is a flare up in the Middle East, interest rates are going to go crazy. If you ladder, it takes the guesswork out because you have money coming due all the time," says Herbert Hopwood, CFP and president of Hopwood Financial Services in Great Falls, Va.
"If you sell something to lock in a higher rate, you're making a bet that the market is inefficient. If you extend a maturity, you're saying that rates will not go up, and I think that is a dangerous thing to do because I think that the markets are fairly efficient," he says.
Have you ever sold out of a CD early and benefitted? In an upcoming blog post I'm going to report on how to build a CD ladder, do you have any questions on the subject you'd like to see addressed?