CD rates are higher, but should you put your money into it? Consider your goals.

This item reprinted with permission from Nerd wallet. The investment information provided on this page is for educational purposes only. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.

The year 2022 hasn’t been kind to our wallets. But between the rise in prices (i.e. inflation) there is at least one advantage: the rates on savings accounts have risen, even on certificates of deposit.

Some CDs have returns above 3% right now, but like any bank account, they don’t work for every financial situation. Let’s see if CDs make sense to you.

Quick Definition: CDs that contain money, not music

If you came to this article thinking of a CD as a compact disc for music, I apologize, but good luck with your old school music collection.

In the banking industry, a CD refers to a certificate of deposit, which is a type of savings account that has a fixed term and interest rate. Add money, wait for the CD term – usually three months to five years – to expire, and you’ll get your money back with interest.

The main places to open CDs are banks and credit unions, which are the non-profit counterparts of the banks. Credit unions tend to call CDs “shared certificates”. Brokers also offer CDs, but the process is more complicated and requires an investment account.

Moreover: Surprise! CDs are back in vogue with Treasury and I-bonds as a safe haven for your cash

CD: The good, the bad, the rigor

Good

Here’s the main reason to consider CDs – they can offer the highest guaranteed returns for a bank account. And current CD rates are among the highest in a decade, based on NerdWallet analysis of the Fed’s data and its own data. When the Federal Reserve raises the rate, as it has done several times in 2022, banks usually increase their savings and CD yields.

Hands down, the best rates are at online-only institutions. At the time of this writing, you can find rates for one-year CD above 2.3% annual percentage return, three-year CD above 2.7% APY, and five-year CD above 3% APY. . The national average CD rates, on the other hand, are less than 0.70%, which is in any case better than the national average of 0.13% on ordinary savings accounts.

Take this scenario: Put $ 10,000 in a 3% CD over a five-year period and you’ll earn about $ 1,600 in interest. Try the same amount and the same time frame but in a savings account with a 0.13% rate and you will earn about $ 65. I would choose the first option.

Unlike some checking or savings accounts, CDs have no monthly fees or minimum balance requirements other than a minimum amount to open. High-yielding CDs have lows ranging from $ 0 to $ 10,000.

The bad

CDs are the bank account equivalent of a safety deposit box. In exchange for high rates, you give up access to funds. The first time you add money is almost always the only time you add money, so you need to agree to transfer a fair amount of money to an account upfront. Then your money is blocked for the term of the CD you choose.

The penalty

If you need to cash out a CD in advance, well, it might hurt. You have to withdraw all the money in a transaction and almost always pay a penalty that can cost anywhere from several months to a year of interest you have earned or would have earned. A bank can use your original amount to cover a penalty. Unlike other bank accounts, however, CDs only have this potential cost, and you can avoid it by waiting for a CD to mature.

You might like: How to turn $ 30,000 into millions: the power of time beats a lucky choice of stocks

When would CDs work best for me?

CDs have more specific use cases than everyday checking and savings accounts. Ask yourself one of these questions before deciding to open one.

1. Do I need more distance from some savings?

Suppose you enter into an inheritance or other kind of fortune; o you have been accumulating savings for years; or are you like my parents who, when they grew up, put savings in a stock certificate to keep it out of reach. Whatever the reason, a CD is built to keep you from being tempted to spend those funds.

2. Do I have savings destined for a large purchase?

If you have an amount earmarked for a car or a down payment on a house over the next few years, a CD helps you put the funds aside until you are ready.

3. Do I want to protect some wealth outside of investment?

CDs provide short-term security, not long-term growth. Funds are federally insured as they are in other bank accounts, which means your funds are returned to you even if a bank goes bankrupt. CDs also do not run the risk of fluctuating value as in the stock market.

CDs “are somewhere between emergency savings and investment,” says Derek Brainard, national director of financial education at the AccessLex Institute, a nonprofit financial literacy organization.

Essentially, CDs are cash reserves for short-term goals. Emergency savings should be immediately accessible if needed, while investing, for example in stocks or bonds, serves to accumulate long-term wealth, explains Brainard.

Visit MarketWatch How to invest page

What if CDs aren’t right for me?

Giving up the thought of high CD rates may be difficult, but you may find that losing access to funds isn’t worth it. However, you can take advantage of the rising rate environment by opening a high yield savings account. Like high yield CDs, these accounts are mostly available at banks and credit unions online only. Many have rates close to 2% APY right now, and you can add or remove money at any time.

Read also: 3 ways retirees can get the most out of their money in an unpredictable market

I want a CD, but what if CD rates go up?

The fixed rate of a CD can be a double-edged sword – it provides guaranteed returns, but if rates rise, you lose the higher rates after you lock yours. And the rates have gone up lately.

“If you believe the rising rate environment will continue, one strategy to offset that risk is the certificate [or CD] scale, ”says CJ Pointkowski, assistant vice president of savings products at the Navy Federal Credit Union.

Scaling CDs, or creating a CD ladder, involves opening multiple CDs of different terms, generally short, medium and long term. A common scale consists of one to five year CDs in which five CDs mature at staggered intervals, as each year for the middle of the next decade. At the end of each CD, you can reinvest in a new five-year CD to take advantage of higher future rates, or you can withdraw the money.

If juggling multiple CDs seems like a hassle, another strategy is to open a CD without penalty. This less common type of CD allows for a free early withdrawal anytime after the first few days, which removes any barrier to switching to a higher rate CD later on. But fees alone shouldn’t guide your decision to open a CD.

“At the end of the day, a CD will be the right tool or not, regardless of what’s happening in the interest rate environment,” says Brainard.

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Spencer Tierney writes for NerdWallet. Email: spencer.tierney@nerdwallet.com. Twitter: @SpencerNerd.

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