Certificates of deposit are accounts that allow you to deposit a certain amount of funds for a set period. The funds stay in the account until they reach their maturity date. By committing to keep money in that account for a set amount of time, you generally earn a higher interest rate than your typical savings account.
CDs traditionally offer fixed interest rates so you can calculate beforehand how much interest you’ll earn over the term, which can be as short as a few months or as long as five years.1 However, if you take money out of a CD before it matures, you can be charged an early withdrawal penalty. This penalty is typically a percentage of the interest earned.
Benefits of opening a CD account
Opening a CD account carries a few unique benefits:
- Higher interest rates on your savings
- Fast growth for money you don’t need to use right away
- A convenient way to stash money for a big purchase
- NCUA or FDIC insurance to protect your money against bank failure
- Fixed interest rate when rates on other accounts may fluctuate
- Ability to withdraw the entire amount when it matures or roll it into a new CD account to keep saving
Often, the longer the CD term, the higher the APY (annual percentage yield). In other words, the longer you agree to keep your money in the CD without withdrawing it, the more interest you’ll earn.
Ideal situations for CDs
When do CDs make sense? Here are a few times you might consider opening a certificate of deposit:
- When saving for a specific goal: If you have a clear timeline for saving – like buying a house, taking a big vacation, getting married, or having a baby – you can select a high-interest CD with a term length that matches your goals.
- When rates are high: If CD rates are significantly higher than typical savings account rates, investing at least some of your savings in a CD may make sense. Just leave enough money in savings to cover emergencies or short-term goals.
- When the stock market is too volatile: Generally, investing in the stock market will yield more long-term growth; historically, the stock market has a 10% annual yield, though this fluctuates.2 However, investing is always a gamble. If the market feels too volatile for you and you want more of a “sure thing,” a CD could be a safer bet.
When to open a CD for the best rate
How do you know when to open a CD for the best rate? You’ll want to pay attention to the various CD rates financial institutions offer. When they seem favorable, open a certificate of deposit and lock in that high rate – before they start to fall back down.
Like any financial decision, it’s always a risk. After all, you could lock in what you think is a strong rate, only for them to increase in the coming months.
Another way to approach CDs is to think about your upcoming financial goals. If you know you have an expensive wedding in two years or want to buy a house in five years, you could put some seed money in a CD that will mature in line with your plans.
Potential drawbacks of a CD account
The main thing to consider when thinking about a CD is whether you’re prepared to stash your money for an extended period of time. Taking it out early could result in a penalty, and you’d lose money in the long run. If you think you might need to tap into your funds sooner, a savings account might be better.
Emergency needs aside, putting your money in a CD also means you have less money to invest in other options, like stocks and real estate.
