How to Choose the Right CD Term for Your Needs

One of the most important decisions you have to make when investing in a certificate of deposit (CD) is how long you want it to mature. CDs are available in several different terms, from months to years. If you choose too short a term, you won’t get as good an interest rate, but if it’s too long, you may have to pay an early withdrawal penalty if you need to withdraw your money before it’s due. The key is to find the sweet spot, a CD term that works best for you.

Key points to remember

  • Certificates of deposit (CDs) come in different terms or terms to maturity.
  • A major consideration in choosing the right CD term is when you think you need the money.
  • If you need to cash in on a CD before the end of its term, you may have to pay an early withdrawal penalty, which could cost you all of your interest and even some of the principal.
  • Building a CD ladder can help you avoid penalties because it divides your investment into multiple CDs that mature on staggered dates.

Find the right CD length for your needs

When choosing the term of your CD, you must first consider how long you can hold your money without touching it. You wouldn’t put your emergency fund savings on a CD because you might need that money before the CD matures. Likewise, if you’re saving for a down payment on a house you know you won’t be ready to buy for three to five years, you wouldn’t choose a six-month CD when you could get a much higher interest rate. raised. over three or five years.

If you’re saving for retirement in a decade or two, you could invest in a longer-term CD, especially if you’re risk averse and don’t want to invest all your money in the stock market.

What CD lengths are available?

CD terms typically range from one month to 10 years, and sometimes longer.

The longer the term, the higher your interest rate is likely to be. On the other hand, the longer the duration, the higher the early withdrawal penalty may also be.

Get the best interest rates

Once you’ve decided on the CD term you want, it pays to shop around to find a bank or credit union that offers the best interest rate on one with that term. You should always make sure that the bank or credit union is insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). With either agency, your total deposits with that financial institution are insured up to $250,000, and if you have joint accounts, that amount is doubled. Coverage is automatic.

As of April 2022, for deposits under $100,000, average CD rates nationwide ranged from 0.03% for a one-month CD to 0.32% for a five-year CD. But rates can vary greatly from one financial institution to another. As a general rule, online-only banks offer higher returns than brick-and-mortar banks.

Also note that some financial institutions pay higher interest rates on CDs above a certain size, such as $10,000. Some also offer jumbo CDs, usually for deposits of $100,000 or more, which offer their highest rates.

Minimum deposit requirements

You will also want to check the minimum deposit requirements of the bank or credit union. Most require a minimum deposit of at least $500 to buy a CD, and many want $1,000 or more. Keep in mind that unlike a savings account, you usually only fund a CD once, when you open it. (There is a specialized type of CD that allows additional deposits, called an add-on CD, but it is much less common.)

Early withdrawal penalties

Another provision to check is whether the CD has an early withdrawal penalty, in case you need to withdraw your money early, and if so, how it is calculated.

These fees vary depending on your particular CD, its duration and the issuer. The longer the duration of the CD, the greater the penalty will normally be. So, for example, the penalty on a five-year CD is much higher than for a three-month CD. Some issuers will charge you for all the interest you’ve earned and even deduct a portion of your principal if you haven’t earned enough interest to cover the entire penalty.

If you’re unsure how long you can leave your CD intact, note that some banks offer liquid CDs or penalty-free CDs, although they pay less interest in exchange.

Take advantage of CD laddering

One way to reap the benefits of CDs both short and long term is to use a CD ladder. Laddering is a strategy of spreading your money among several CDs with different terms.

For example, instead of buying a single five-year CD with $5,000, you can put $1,000 each into one-, two-, three-, four-, and five-year CDs. That way, you’ll still have a CD maturing within a year, while earning a higher rate on at least some of your money. When your one-year CD matures, you invest the money in a new five-year CD. A year later, you invest the proceeds from your two-year CD into a new five-year CD, and so on.

A ladder can also prevent you from locking up all your money at a low rate.

What happens when a CD matures?

By law, if your CD has a term of one year or more and you have not chosen to renew it automatically, the financial institution must notify you when it is about to expire. At this point, you’ll have the choice of rolling the money to another CD, transferring it to another account, or just taking it in cash. If you don’t do anything by the deadline the financial institution gives you, they will usually put the money on a new CD, locking it up until that CD matures.

What is a traded CD?

Traded CDs are certificates of deposit issued by banks but sold by brokerage firms and independent sales representatives. They can pay higher rates than CDs sold directly by banks and credit unions, but can also be riskier. Before buying one, make sure you are dealing with a reputable company. Also make sure the CD is federally insured.

What is a callable CD?

Some certificates of deposit, like some bonds, have a provision for the issuer to call them before they mature. An issuer might do this, for example, if you have a long-term CD with a high interest rate and interest rates have gone down since you bought it. You’ll get your money back and any interest you’ve earned so far, but you’ll have to invest the money elsewhere, probably at a lower rate. So when you’re buying a CD, it’s worth considering if it’s callable.

The essential

CDs are available in a wide variety of terms or lengths. The trick to choosing one is finding the right balance between a short-term CD (which lets you withdraw your money sooner) and a long-term CD (which will pay a higher interest rate). You can also divide your investment between several CDs of different durations to hedge your bets.

Jack L. Goldstein