How to invest with CDs
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If you’re looking for ways to turn your stash of savings into something bigger, investing in a certificate of deposit (CD) is one way to watch it grow that comes with little risk. Plenty of banks and credit unions offer high yields on their CDs, and you can develop a strategy for investing in one or several CDs with varying term lengths, depending on your goals.
Here are some factors to consider when choosing a CD investment strategy.
Are CDs a good investment?
For risk-averse investors, CDs could make sense as part of a diversified portfolio: They offer a guaranteed return on your money that you don’t need right away. That could be an advantage when rates are high.
“The rising rate environment gives people the option of locking in at a fixed rate without fear of loss,” says Mike Hunsberger, the owner of Next Mission Financial Planning in Missouri. “The bad part is that, even though rates have risen, with inflation so high your real rate of returns for CDs is still negative.”
Other low-risk investments may offer better returns for investors, depending on their needs.
Nevertheless, a CD still provides a better return than a savings account, and is especially suited for someone with a defined goal, Hunsberger says.
Can you lose your money in a CD?
CDs come with a guaranteed rate of return — the rate you get when you open a CD stays the same until its maturity. The money you earn from interest, plus the principal balance, are protected by federal insurance, as long as the issuing bank or credit union is part of the FDIC (for banks) or NCUA (for credit unions). Federal insurance covers up to $250,000 per bank, per depositor.
The one instance where an investor could lose money from a CD is if they withdraw funds before the CD’s maturity date. The penalty could eat into earnings or even some of the principal balance, so it’s important to only open a CD that you can confidently commit to leaving money in until its maturity date.
How much can you make investing in CDs?
Potential earnings from CD investments are based on a few key factors: how much you deposit, the CD’s interest rate and its maturity date. For example, let’s say you deposit $20,000 in a 3-year CD that pays a 3.10 percent APY. You would earn $1,918.26. To get a good idea of how much you may be able to earn from a CD investment, use Bankrate’s CD calculator.
What is the minimum investment for a CD?
The amount required to invest in a CD depends on where you want to open it. For example, Capital One has no account minimum balance requirement, while one CD option at Bank of America requires depositing at least $10,000.
CD investing strategies
Many CD investors opt for a more in-depth strategy than simply choosing one CD for their funds. Since CDs are available in a range of maturities, you can consider purchasing multiple CDs with different term lengths to maximize your earnings while freeing up some of the funds sooner for reinvestment.
CD laddering is arguably the most common CD investing approach. For example, let’s say you have $6,000 you plan to invest in CDs. Here’s how a ladder might look:
$2,000 in a 1-year CD
$2,000 in a 2-year CD
$2,000 in a 3-year CD
When the 1-year CD matures, you would reinvest in another 3-year CD. This way, your money is regularly maturing, and that gives you two key benefits.
First, if you need access to some of the funds, the next maturity date is fairly close. Second, you’ll hopefully be able to take advantage of higher interest rates when you reinvest to continue to maintain the ladder. It’s important to note that you do not have to divide the funds equally (as in the example above). You can choose any amount in each CD, in order to maximize earnings on CDs with higher rates.
While a ladder has multiple steps with even space between them, a barbell skips all those middle rungs in favor of short-term CD investments and long-term CD investments. For example, a barbell might look like this:
$2,000 in a 1-year CD
$2,000 in a 5-year CD
The benefit of pairing long-term investments with short-term ones is that the investor can use shorter term CDs to take advantage of higher rates, while the longer term CD serves as a safety net in case rates fall.
With a CD bullet strategy, you pick a target date for the bullet, and invest in CDs accordingly. So, you might invest in a 5-year CD today. Next year, you invest in a 4-year CD, and the following year, you invest in a 3-year CD. All of the CDs will mature around the same time, so the bullet strategy may be good for investors looking to achieve a specific goal by a certain date.
A benefit of the bullet strategy is you won’t have to invest the entire amount at one time, and there’s a chance you’ll be able to pick up higher rates along the way on the shorter term CDs.
Different types of CDs
All CDs are not created equal. If you are comparing CD investments, here’s a rundown of some of the common alternatives to traditional CDs:
Bump-up CD: A bump-up CD gives you the option to request a rate increase a certain number of times during the term. So, let’s say you open a 2-year CD with a 1.50 APY, and eight months later, the rate is 2.00 APY. You can ask for the increase. Typically, these CDs only allow for one increase per term.
Step-up CD: A step-up CD is similar to a bump-up CD except the bank does the work for you. You’ll have an idea of the rate increases before you open. For example, U.S. Bank’s 28-month CD starts with a 0.05 percent APY and increases by 0.2 percent every seven months.
No-penalty CD: With a no-penalty CD, the name says it all: You don’t have to worry about handing over any earnings if you make a withdrawal before the maturity date.
Add-on CD: Add-on CDs function more like a standard savings account. After you open the CD, you can make additional deposits to the principal. Some add-on CDs allow for unlimited additional deposits, but others may have limits on how many contributions can be made.
Callable CD: Callable CDs put more power in the bank’s hands to call – close out – your CD. For example, let’s say your CD is paying a 3 percent APY. If interest rates drop and the bank doesn’t want to pay that much interest, it can call your CD.
Steps to get started investing in CDs
Start by comparing CD rates to get a sense of where you will find the most attractive earning potential and which term lengths match up with your end goals. For example, if you’re looking to make a down payment on a house in three years, look for CDs that mature before the three-year mark.
Then, think about how much money you can confidently deposit and stash away for the length of the CD term.
You can use Bankrate’s CD calculator to determine what you will earn before you decide to open a CD.
Mistakes to avoid
Opening a CD is a simple process, but there are some stumbling blocks that can get in your way. Avoid these errors to make sure you are maximizing your earnings and minimizing your chances of penalties.
- Forgetting to account for inflation: Though there’s a current rising-rate environment, inflation continues to intensify, too. The real rate of return on a CD that matures while inflation is still rising could be much less than anticipated.
- Choosing the first CD you see: Many banks and credit unions offer CDs, and these offerings come at varying yields. You can use Bankrate’s best CDs list to compare some options.
- Failing to consider penalties and more flexible alternatives: An investor may want to consider other types of CDs besides traditional CDs. A no-penalty CD may be a good option for an investor looking for more flexibility with their deposit, and a bump-up CD can reduce the risk of missing out on rising interest rates.
Let’s look at a CD ladder with $15,000 that bets on interest rates continuing to rise during the year. If you’re banking with Ally Bank, it might look like something like this:
- $5,000 in a 6-month CD with a 1.00 percent APY
- $5,000 in a no-penalty CD with a 1.15 percent APY: While this yield is somewhat lower than the bank’s standard 1-year CD, it is still higher than shorter standard CD terms, so you’d earn the higher rate even if you withdraw the funds earlier than a year.
- $5,000 in the bank’s 2-year Raise Your Rate CD: This is a bump-up CD with a current 2.00 percent APY. If rates continue to increase, you can take advantage of extra earning ability.
Again, it’s important to note that the amounts in a ladder do not need to be even across all maturity dates. How you allocate funds in the CD ladder depends on your cash flow needs and projected goals.
“To get a higher yield, I will typically have more funds later in the ladder,” says Casey T. Smith, president of Georgia-based Wiser Wealth Management. “If you think interest rates will rise in the next year, then you would build the ladder with more maturing sooner.”
Investors looking for a low-risk investment with a guaranteed rate of return have many CD options to choose from.
CD rates are competitive in a rising-rate environment, which makes it all the more important to shop around and find the best rates for the terms you’re seeking. Additionally, you might consider an investment strategy that takes advantage of multiple CDs at different term lengths. Just be aware of penalties for taking money out of the CD earlier than its maturity date.
–Staff writer René Bennett contributed to this article.