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CDs can be a great way to lock in a yield on your savings, but there are other factors to consider. Keep reading for expert CD advice. [[{“value”:”
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Certificates of deposit, or CDs, can be a great way to lock in a guaranteed APY for a certain amount of time. However, they aren’t the best choice for your extra cash in every situation, and there are some things you should keep in mind before deciding if a CD is right for you.
As a Certified Financial Planner™ who has lots of experience with CDs, savings accounts, investing, and more, here are three important things to consider before you decide to put money into a CD in 2024.
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1. Be sure to consider the drawbacks
CDs certainly have their advantages over checking and savings accounts, but they aren’t perfect.
The first, and most obvious drawback, is the early withdrawal penalty you’ll have to pay if you take money out of the account early. In most cases, a CD early withdrawal penalty is equal to a few months’ worth of interest. And it’s worth noting that you typically can’t withdraw just some of the money in a CD early. If you choose to take money from your CD before it matures, you’ll have to take it all (and pay the penalty on the full amount).
Second, while locking in a guaranteed CD interest rate can be nice, it also has its risks. For example, let’s say that you get a 5-year CD with a 4% APY, and rates proceed to spike to 5% or 6%. You’re stuck at a lower interest rate for several years.
Or let’s say that you have a 5-year CD with a 4% APY and the inflation rate jumps to 5% or even higher. Now your money is effectively losing purchasing power over time.
2. Use CDs for financial planning
Many experts advise savers to think of CDs as financial planning tools that can be used to anticipate future cash needs. And I tend to agree.
Here’s an example. If you are planning to take a family vacation one year from now and you estimate that it will cost a total of $5,000, you could open a 1-year CD to set the money aside and earn a guaranteed yield in the meantime.
If your biggest priority is growing your wealth over time, investing can be the better way to go. But CDs can be a great way to get a risk-free yield while planning for known expenses.
3. Make sure your emergency fund and retirement take priority
As a Certified Financial Planner™, I’d strongly suggest that two specific financial goals take priority over setting aside money in a CD.
The first is emergency savings. Most experts suggest that you should aim to have six months’ worth of expenses set aside in a readily accessible account (perhaps a savings account). That way, if you lose your job or have a large, unexpected expense, you won’t have to use your credit cards or tap into long-term savings.
Second is retirement savings. A good rule of thumb is to contribute at least 10% of your salary (not including any employer matching contributions) into a tax-advantaged retirement account to save and invest for your future financial security.
If both of these things are done, you can consider a CD for any additional cash you have. But only after these two critical financial needs are met.
Are CDs right for you?
Like any financial product, CDs have pros and cons that are extremely important to consider before you deposit money into one. It’s also worth noting that CD rates can vary significantly from bank to bank, so be sure to shop around with some of the best banks for CDs before you make a decision. But as long as you’re aware of the drawbacks and use CDs in the right way, they can be an excellent way to create a predictable income stream with little risk.
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