5 Tips for Choosing the Highest-Yielding CDs
Certificates of deposit (CDs) can be ideal for beginning investors. They’re relatively low risk when you compare them to other more volatile financial products, like stocks, because they typically don’t lose value and aren’t as affected by market fluctuations in either direction. But not all CDs are created the same — different banks’ CDs can have different interest rates, and those rates play a primary role in determining how much you’ll earn from investing in a CD.
It makes sense, then, that you’ll want to opt for higher-interest-rate CDs to boost your earnings if you want to start adding (or add more) CDs to your portfolio. Before you make the leap, check out these tips to learn more about where to find high-yield CDs, which types you’ll want to consider and what you need to know about modifying your investment strategy to make the most of the experience.
Consider Your Ideal CD Investment Term
The reason CDs tend to offer higher interest rates than high-yield savings bank accounts is that CDs operate on the assumption that you won’t be withdrawing your money for a predetermined length of time. For this reason, CDs tend to be a favorite tool of investors who focus on long-term investments; CDs can lock up your money for anywhere between three months to five years. Generally speaking, the longer the length of your CD term is, the higher its interest rate will be.
That said, it’s important to be realistic about your goals. Don’t throw all your savings into a five-year CD just because it has the highest yield if there’s a chance you may need to withdraw some of the money before the maturity date. If you do, you may incur penalty fees that defeat your purpose of investing in CDs in the first place. If you’re looking to enjoy long-term yields without tying up all your money at once, building a CD ladder may be an ideal option.
Be Aware of Early Withdrawal Fees
Life happens. While few people invest in a CD expecting to need to make an early withdrawal, sometimes unexpected emergencies present costs you simply can’t avoid. If you do end up needing to withdraw your money from a CD early, you may incur an early withdrawal penalty fee. But it’s important to note that some are steeper than others.
These types of penalty fees usually take the form of a portion of the interest you would’ve earned on your investment, but some banks may take all of your earned interest completely. Make sure to read the fine print and fully understand what the penalty will be if you need to cash out before the maturity date. Find out whether the fee comes out of simple or compound interest of the amount you withdraw. If you’re not certain you won’t need the money before its maturity date, focus some of your efforts on investing in no-penalty CDs.
Check Out CDs From Online Banks
As recently as a few decades ago, we might never have thought banks could operate without physical, brick-and-mortar locations. These days, however, there are plenty of reputable banks that exist primarily or entirely online. Due to their lower costs of operation, they often offer plenty of perks to members, including higher yields on savings accounts and CDs.
While this isn’t always the case, you may have a better chance of finding CDs with 1% or higher interest rates if you focus your search on online financial institutions. Be sure to do plenty of research, though, because rates are constantly changing. Try searching for online banks’ CDs based on the ideal length of time you’d like to invest.
Look Into Bump-Up CDs
One worry that CD investors sometimes have is that they’ll be locked into an interest rate for several years. Even if CDs have rates on the higher end, many offer relatively low returns when you compare them to the return on investment you can achieve with other financial products, such as stocks. What do you do if you invest your money for five years, only to see interest rates available elsewhere suddenly start to rise a year down the line?
Bump-up CDs offer a solution by giving you an option to boost your annual interest if rates rise during your CD’s investment term. If you sign up for this type of CD, keep in mind that you’ll need to request the bump-up from the bank in order to activate the higher interest rate — it doesn’t happen automatically.
Understand How Step-Up CDs Work
While bump-up and step-up CDs are often mistakenly referred to as the same thing, they’re two different products. They do work similarly, but they have a key difference. Step-up CDs, while increasingly rare these days, are also intended to add a measure of protection against rising interest rates, but in a different way. Rather than allowing you to ask to raise your interest rate during your CD term, they start you out at a specific interest rate for a period of time and automatically increase that rate at predetermined future dates.
Here’s an example of what these increases might look like:
- 0.05% for the first seven months of the term
- 0.25% for next seven months
- 0.45% for next seven months
- 0.65% for next seven months
While this might initially seem like a good deal, make sure you always review what’s called the blended rate. This tells you the average of all the rates to show you how much you’ll actually earn over the course of the investment. In the case of the example step-up CD above, the blended rate comes out to 0.35% — which isn’t great compared to other CDs with fixed terms.
What Are Some Pros and Cons of CD Investing?
Investing in CDs can be ideal for a number of reasons, but you’ll want to make sure they fit your financial strategy before you put money toward one. Here’s a breakdown of some of their primary pros and cons:
- Safety: CDs are FDIC-insured and are about as low-risk as investments get.
- Predictability: CDs are pretty straightforward in that you can predict the exact amount you’ll earn when your term ends.
- Potential higher rates: CDs tend to offer higher rates than savings accounts and money market accounts.
- Cost: CDs typically don’t have monthly maintenance fees.
- Potential for lower returns: While the rates of CDs may outperform those of some savings accounts, they can vastly underperform compared to higher-risk investments such as stocks or exchange-traded funds.
- Penalty fees: CDs are a good option if you can invest money that you’re reasonably certain you won’t need for the entire length of the term. Otherwise, you may face early withdrawal penalties.
- Interest rate risk: Unless you invest in a bump-up CD, you always run the risk that interest rates will suddenly rise while your money is still tied up — and you’ll lose out on that potential for higher earnings.
- Inflation risk: Putting your money into a long-term investment with a fixed rate (especially a low one) always comes with the risk that your money won’t gain value while it’s tied up for years if the inflation rate outpaces your earnings.