Sep 17 · 5 min read
Interest rates on traditional savings accounts can be almost nonexistent. While high-yield savings and money market accounts serve as great alternatives, a certificate of deposit (CD) could be an even better one.
Certificates of deposit, also known as CDs, are savings accounts that typically have higher interest rates than both high-yield savings accounts and money market accounts. This higher interest rate comes with a few small catches though. You usually won’t be able to deposit more money into your CD after you make your initial deposit and you won’t be able to touch your money until after a set amount of time.
Although you won’t be able to withdraw your money for some time, you will be able to choose this time frame yourself. This time frame is called your “term”. Generally, the longer the term, the more interest you’ll earn. Banks can offer CDs with terms that range anywhere from 1 month to 5 years. Since you are rewarded for choosing longer terms, 1 month CDs will have the lowest interest rates while 5 year CDs will have the highest.
Before choosing the term for your CD, you’ll want to make sure you can leave your money untouched for that long. If you withdraw your money before the term is up, you’ll typically be charged an Early Withdrawal Penalty. Early withdrawal fees can amount to months of interest so choose your term whyzely or stick with a high-yield savings or money market account if you think you might need your money before the term is over.
After you decide the best term length for your CD, you will deposit your money and leave it untouched until the end of your term. The last day of your term is called the “maturity date”. Once your “maturity date” is met, you can either withdraw your money plus the interest earned or reinvest it into another CD. If you choose to do nothing, your money will automatically be placed into a new CD with a similar term as your last one.
While most CDs have a fixed term length and a set APY, some banks offer CDs that operate a little differently.
If you like the high interest rates of a 3 to 5 year CD but are wary of not being able to touch your savings for that long, you’re not alone. You can overcome this dilemma by using a CD Ladder strategy. This strategy involves dividing your money over multiple short and long term CDs instead of just buying one long term CD.
As an example, let’s say you have $15,000 and are looking to build a three-year CD Ladder. Your first step would be to divide this money evenly and invest $5,000 into three different CDs. $5,000 into a one-year CD, $5,000 into a two-year CD, and $5,000 into a three-year CD. The next year, you would reinvest the money from the one-year CD into a three-year CD. The year after that, you would reinvest the money from the two-year CD into a three-year CD. You repeat this again the next year for your last CD, reinvesting the money from your three-year CD into another three-year CD. Now you have your ladder set up. At this point, you’ll have the option to cash out or reinvest a CD every year.
Using the same example, let’s say you have $15,000 and are instead looking to build a 5 year CD Ladder in order to get higher interest rates. Your first step again would be to divide this money evenly and invest $3,000 into five different CDs. $3,000 into a one-year CD, $3,000 into a two-year CD, $3,000 into a three-year CD, $3,000 into a four-year CD, and $3,000 into a five-year CD. The next year, you would reinvest the money from the one-year CD into a five-year CD. The year after that, you would reinvest the money from the two-year CD into a five-year CD. You would then repeat this cycle until you reinvested the money from your original five-year CD into another five-year CD. Now you’ll have your ladder set up. At this point, you’ll have the option to cash out or reinvest a CD every year but with higher interest rates than the three-year ladder.
Whether you decide to buy one CD or start a CD Ladder, you’ll want to compare these key details.
The most important detail is how much interest you’ll make. This will be shown as an Annual Percentage Yield (APY). APYs reveal exactly what percentage of your money you’ll get paid in interest over the timespan of a year. The APY for a CD with a term longer than a year shows you how much interest you will make each year until your term is complete.For instance, if you deposited $10,000 into a three-year CD offering 2.5% APY, you’ll earn $250 in interest the first year, $256.25 the second, and $262.66 the third year if you leave your money untouched.
Another detail you should compare is the minimum balance required to open a CD. Depending on the bank or credit union, minimum balances can range from $1 to over $10,000. Although, CDs with higher minimums tend to have higher APYs.
Account fees should also be a major factor in choosing your money market account. Fees can easily wipe away your interest and should be avoided or minimized when possible. When comparing banks, you should focus on these common fees:
Ultimately, if you’re looking to earn more interest on your savings and can afford to let your money sit untouched, then CDs might be your best option. As you look to grow your savings with this type of account, make sure you compare the key details and choose the one that best suits your needs and timeline.