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Certificates of deposit (CDs) are less common than savings accounts, but they could help you earn as much or more over time, as long as you’re comfortable leaving your money alone for a while. But if you want to maximize your earnings, you have to choose the best CD for you.
The account’s interest rate is a key factor in the decision, but the term length matters too. Here’s what you need to know to decide which CD is best for you in 2024.
Short-term CDs: Big rewards now, but will they last?
Short-term CDs are CDs with shorter term lengths — one year or less. For those who need a quick refresher, the CD term is the amount of time you must leave your money alone. You’ll earn an agreed-upon interest rate that’s locked in when you open the account. But if you withdraw your cash before the term is up, you’ll pay a penalty equal to several months’ lost interest.
Short-term CDs have historically had lower interest rates than longer-term CDs, but the high inflation and economic uncertainty we’ve been facing since early 2022 has left many banks hesitant to lock in high rates on long-term CDs. So many have opted to raise their short-term CD rates instead to draw in customers.
Some of the best CD rates today are short-term CDs with interest rates exceeding 5.00%. These are great options for those who want to earn a high rate of interest, but don’t want to lock their money up for long. For example, if you have a large planned expense coming up in a year, going with a 1-year CD makes more sense than sticking your money in a 5-year CD.
But the thing about short-term CDs is your rate isn’t guaranteed for as long. If CD rates begin to fall, as they likely will when the Federal Reserve eventually lowers the federal funds rate again, all CDs will get less appealing. And short-term CDs might suffer in particular given that they’re unusually high right now.
Long-term CDs: Potential for big returns, but patience is required
Long-term CDs are CDs with terms of a year or more. It’s common to find terms ranging from one to five years, but some banks offer CDs with terms as long as 10 years. As mentioned above, most of the time, longer-term CDs have higher interest rates to incentivize people to keep their money with the bank for longer. And, as with short-term CDs, rates are locked in for the full term.
This makes long-term CDs more popular when interest rates are falling. You lock in your rates when they’re high and you can earn a larger profit over the course of several years than you could by investing in one short-term CD with a high interest rate and then several more with lower rates.
Say you have $1,000 to invest in a CD. If you put it in a 1-year CD with a 5.00% annual percentage yield (APY), you’d make $50 during that year. Then, let’s say you invested that $1,050 into another 1-year CD, but by this time, rates had fallen to 3.00%. If 1-year CD rates held steady at 3.00% for the next four years, your balance at the end of five years would be about $1,181.
Had you invested your initial $1,000 in a 5-year CD with a 4.00% APY instead, you would have wound up with $1,217 when all was said and done. So while initially, it may not have seemed like the most appealing option, it could actually be more rewarding in the long run.
But, of course, there’s the early withdrawal penalties to think about. If you don’t think you can leave your cash alone for the entire CD term, it’s probably not the best home for your money.
No CD: Alternatives to consider
Sometimes, a CD of any length isn’t a good fit. If you’re looking for a place to keep your emergency fund, for example, you definitely don’t want to lock it up where you can’t access it. A high-yield savings account is a much better option for this sort of thing.
Or, if you don’t plan to use your money for the foreseeable future, you might prefer to invest it. There’s a risk of loss, but you could also earn significantly more than you could with even the best CDs.
It doesn’t hurt to explore all your options before deciding where to put your cash. It’s possible to undo your choice to place your money in a CD or invest it. But it’s a lot easier to just make a decision you’re comfortable with from the start.
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