This is the worst type of CD to open right now.
As long-awaited certificate of deposit (CD) interest rates begin to fall, many people are rushing to secure higher annual percentage yields (APY). At today’s rates, you can make hundreds of dollars in a year, but it comes at a cost.
That price is enough to deter many people from opening one of these accounts. But if you’re thinking of giving CD investing a try, there’s one type you should definitely avoid.
The price you pay when you open a CD
CDs promise guaranteed profits with no monthly maintenance fees, but your money is virtually untouchable during the CD term. This can take months or years.
Technically, you can withdraw cash whenever you want. However, you must withdraw it all in one lump sum, and early withdrawals typically incur a penalty of several months’ worth of interest payments. If you change your mind immediately after opening the CD, you may lose some of your principal this way.
Long-term CDs of one year or more generally have the highest return potential, but they take a long time to give up control of your cash. This can be a problem if unexpected costs arise. If you don’t have a separate emergency fund, you may have to endure early withdrawal penalties to get the money you need.
Not always a good investment
Even if you can leave your cash untouched for the entire period, you could still end up short on your own. Currently, the best 5-year CD interest rate is close to 4.00%. With an initial deposit of $1,000 you can earn $221. But if you invested that $1,000 and earned an average annual return of 10%, after five years it would be worth $1,611.
There’s also no way to know what CD interest rates will be in a few months, let alone a few years. It’s at a high level right now, so it’s reasonable to assume it will fall at some point. That’s why many people think now is a good time to secure high interest rates.
But this is also why long-term CDs are bad investments for most people. There is always a possibility that interest rates will rise in the future. If you lock in a lower interest rate now, you’ll be locked in there until the end of your CD term unless you pay an early withdrawal penalty.
Forget long-term CDs: try these instead
Rather than tying up your cash for years, consider putting it away in one of these accounts.
high yield savings account
The best high-yield savings accounts currently have interest rates close to 5.00% and don’t prevent you from taking out cash like CDs do. However, the interest rate is not fixed. When interest rates fall, your monthly interest payments will be lower. However, it may rise when bank rates rise.
short term CDs
Short-term CDs typically have lower APYs than long-term CDs, but that’s not currently the case. The best CD prices today come with CDs with a one-year term; These are still hovering around 5.00%. This is enough to earn $51 with a starting balance of $1,000. Plus, your money won’t be tied up for long.
CD ladder
A CD ladder is where you split your money between CDs of different lengths (e.g. 1-year CD, 2-year CD, 3-year CD). When the term of your first CD is over, you can use the cash, move it to a savings account, or invest it in a new CD. Then do the same with the other CDs as they mature.
This allows you to access some of your cash each year. It also gives you plenty of opportunities to get the best current CD prices, so you’re less likely to lose money than if you poured all your cash into one long-term CD.
You can also spread your money between these options if you wish. Think about what’s most important to you – a high interest rate or easy access – and make your decision.
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