When shopping for CDs, it pays – and by that, we mean puts dollars in your wallet – to be aware of the current interest rate environment and available offerings.
The Federal Reserve has raised the federal funds rate nine times since December 2015. These increases are a part of the reason CDs have higher annual percentage yields (APYs) than they did for the seven-year period (from December 2008-December 2015) when the federal funds rate remained near zero.
The Federal Reserve has paused its rate increases for the time being, but you can still take advantage of current CD yields while giving yourself the flexibility to see which direction rates head in the future.
You won’t necessarily grab the best rate by opening a CD at the bank where you keep your checking account. That is especially true if you’re a customer of a large national bank. They often pay the lowest rates in the market. You want to hunt for the best option for you.
Follow these top 18 CD strategies to make the best investment.
1. Determine what the money is for
What are you saving for? Figuring this out will help you evaluate the time horizon for the money. If the funds are likely to be used within the next few months, a savings account or money market account is probably a better option than a CD.
“The first thing that we do is think about when money might be used, or if it’s earmarked for a specific goal,” says Lauren Zangardi Haynes, CIMA, certified financial planner at Spark Financial Advisors.
One smart reason to save in a fixed-rate CD: You’ll know exactly how much money you’ll earn during the term.
Also, if you’re trying to grow your money more aggressively, other types of investment products would be a better fit. Investments like stocks, mutual funds and exchange-traded funds (ETFs) may offer higher gains. But they also have the potential to lose principal.
2. Decide how much needs to be liquid
If the $10,000 you have in your money market account is your only savings, you don’t want to tie it all up for the next five years. Set aside the portion that’s not your emergency savings.
Just remember, longer-term CDs generally pay higher rates. Though in the current CD rate environment, most CDs with terms more than two years aren’t offering much higher yields than shorter-term CDs.
3. Shop around
You can’t know a good deal without doing some research. Start by learning what your existing bank has to offer. Then compare that to what the average CD pays. If your bank offers rates that are significantly higher than the average, your bank is offering good deals.
Next, look online for the best CD rates in the terms you’re considering.
You may notice that many online banks pay higher rates than others. Those banks don’t have the expenses related to a branch network, so they can pay you more.
Similarly, credit unions are able to pay higher rates because they are not-for-profits.
4. Confirm the CD is insured
CDs are smart investments if you don’t want to lose your principal amount. CDs provide safety in the form of principal protection if the account is insured by the Federal Deposit Insurance Corp. (FDIC) and within insured limits. Each depositor at an FDIC bank is insured to at least $250,000 per insured bank, according to the FDIC.
If your CD is at a National Credit Union Administration (NCUA) credit union, then the NCUA operates and manages the National Credit Union Share Insurance Fund (NCUSIF). The standard share insurance amount is $250,000 per share owner, per insured credit union, for each account ownership category, according to the NCUA.
5. Decide whether the CD term makes sense for you
If you will need your money before the CD term ends, a CD isn’t the best place for those funds. If you must withdraw your money early, you may be hit with an early withdrawal penalty, which may negate your interest earnings or even cut into your principal.
6. Consider promotions
That bank around the corner or the local credit union making a play for more deposits may offer you a bonus to park your money there.
Banks and credit unions may offer special rates typically reserved for larger deposits or extra incentives for agreeing to ditch paper statements in favor of electronic versions.
Community banks, perhaps looking to build better relationships, may offer CDs with attractive rates to people in specific cities or counties.
Take a look at the institution’s standard rates. This will give you some idea of whether CD rates upon your renewal will be competitive.
7. Avoid automatic rollovers
Especially if you get a promotional rate, remember to evaluate your CD when it matures, or it may renew at an unfavorable APY.
But regardless of whether you get a promotional rate, know when your CD matures so you can evaluate your options at the end of the term. A CD that boasted a competitive APY when you first deposited your money might not be competitive when it renews. That’s especially true in today’s uncertain rate environment.
8. Figure out when you’ll need the money
Determining when you’ll need the money will help you avoid early withdrawal fees. While emergencies happen, you should have an idea of when this money will be needed. That will help you determine the term of your CD, which typically range from one year to five years.
If you want to buy a house in a couple of years, a one-year CD would be a good investment because you would protect principal and earn a competitive APY.
“We don’t necessarily want to take on a lot of risk by investing it, but we’d like to earn a little more interest,” Zangardi Haynes says.
If the money is for your emergency fund, part of the money can go in a high-yield savings or a money market account, and then a portion can go in a CD to get a higher APY. This will ensure that you have funds in place for your more immediate transactions and for unexpected instances.
Money that you won’t need for at least five years will likely earn a higher yield in other investments, such as stocks, mutual funds or ETFs, but this isn’t guaranteed.
9. Choose an online bank
If you’re looking for the highest APY, a direct bank is a good place to look. If you want to sit down with a representative and talk about options, then the traditional brick-and-mortar bank might be the place to go, but the APY will likely be lower.
Online banks tend to offer higher yields and lower fees. That’s generally because they don’t carry the same overhead costs compared with walk-in branches, and they can pass on that savings to customers.
For example, Sallie Mae Bank, an online bank, offers a 2.7 percent APY on its one-year CDs – more than three times the national average of 0.88 percent APY. On the other hand, Bank of America has a 12-month promotional CD of 0.41 percent APY on all balances.
You can compare CD rates on Bankrate to find the right account for you.
10. Look at minimum deposit requirements
Make sure that the CDs that you’re researching have a balance requirement that fits the amount of money you’re planning to deposit.
If you have $1,000 or less to invest, for example, that might not be a big enough deposit for some banks offering the highest CD rates.
Sometimes a CD will pay a higher APY if it has a higher minimum balance requirement. Other times, CDs with lower minimum balances will pay a competitive APY.
11. Be aware of (and avoid) fees
When shopping for a CD, find out the early withdrawal penalty. While you should be purchasing a CD only if you’re confident that you won’t be touching the money before it matures, it’s good to know what the worst-case scenario will be.
If your goal is to earn the highest interest rate, these CD clauses could really put a dent in that plan if an emergency expense arises or if you’re enticed by a higher yield elsewhere.
You could end up walking away with less money than you started with if you have to end the agreement early.
A penalty of 90 days’ worth of simple interest is a common early withdrawal fee on a one-year CD, though some banks have penalties of six months’ worth of simple interest or more. Other banks may have even steeper penalties or may penalize based on a percentage of the withdrawal.
Some banks may have a penalty of 540 days of interest on a five-year CD.
12. Know how often the CD compounds
Find out how often the CD compounds interest and factor this into your purchasing decision. Compounding is when interest is paid on principal and on the interest that’s already accumulated. This is already included in the APY, which is why it’s important to compare APYs rather than comparing interest rates.
The more often the CD compounds, the better. Always try to find CDs that compound daily. Daily compounding is the most common frequency, but some banks may compound monthly or even more infrequently.
13. Go short term
While interest rates have increased, going for the shortest term with the highest APY is a good strategy. Weighing the benefit of the APY against the next-longest CD term – and how much you think CD rates will change during the term – will help you determine how long to lock your money in.
Remember, if your choice is between a CD and a savings account – and the APY is the same – go with the savings account because it offers liquidity and full access to your money at any time. Go with the CD if you’re being rewarded with a higher APY for the term and won’t be touching these funds during the CD’s term.
14. Ladder your CDs
A CD ladder is when you open multiple CDs maturing at different intervals to take advantage of higher interest rates. CD laddering lets you earn the higher yields offered on those longer-term CDs while still having cash in hand as the shorter-term CDs mature.
For example, you could open three CDs – a one-year CD, two-year CD and a three-year CD. This strategy gives you the flexibility to avoid early withdrawal fees if you need money sooner than expected. It also helps you to diversify your CD portfolio – assuming the longer-term CDs are currently earning a higher APY.
In a rising rate environment, a CD ladder may be a good strategy for some customers, says Crystal Rau, certified financial planner at Beyond Balanced Financial Planning.
“You get to take advantage of the short term one’s maturing and reinvesting those at higher rates if they do increase,” Rau says. “However, if they don’t, then you have those longer-term ones – and they’re getting the better rate.”
15. Consider the indexed, or structured, CD
One nontraditional CD is the structured CD, which is linked to some other type of investment, such as the stock market, currency market or commodities. Though they likely won’t lose money as long as they are held to maturity, returns are typically capped at a percentage of the total return of the underlying index or basket of securities.
For example, if it’s linked to the S&P 500, and that index returns 10 percent over the year, a structured CD may yield three-quarters of that. However, it varies among products. That is one of the criticisms of structured CDs: They can be more complex compared with a conventional CD. But the potential for greater returns pulls in savers.
16. Look at bump-up CDs
Some types of CDs are better suited for low-rate environments than others. Take the bump-up CD as an example.
If interest rates go up, a bump-up CD allows the owner to seek a CD rate increase. With interest rates uncertain in 2019, longer-term bump-up CDs may be just the ticket for savers concerned about chasing yield and interest rate risk.
Rates on bump-up CDs are typically competitive with traditional CDs but are less than a special promotional rate.
17. Consider a barbell strategy
A barbell is another CD investing strategy. It’s very similar to a ladder, but the middle rungs are missing. Short maturities make up one end of the barbell, or investors may even put money in a high-yield savings account to keep part of the principal more liquid. Long-term maturities make up the other end of the barbell.
If you’re looking at a longer-term CD, weigh the potential increase in APY with the potential early withdrawal penalty, says Amy Hubble, Ph.D., CFA, certified financial planner at Radix Financial LLC.
“You can usually get the most value by going ahead and do the longest-term CD that they offer, which is usually five years,” Hubble says.
18. Explore different product types
Different types of CDs can be useful in different situations. For instance, a step-up CD could have a favorable future APY. Step-up CDs generally have a pre-determined APY in future years. Make sure you compare the blended APY to see what the APY averages out to during the CD term with fixed-rate CDs. Brokered CDs can be another option because they may offer a higher APY than a bank CD. They may offer a solution if you’re trying to get FDIC-insurance coverage at multiple banks. Always confirm that your CD is FDIC insured – within the insurance limits – if you’re purchasing a brokered CD.
Also, ending a brokered CD early is far more complicated than with a traditional CD, which you typically can close by paying an early withdrawal penalty.