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- Experts say the best place to save money is somewhere it can earn interest.
- Certificates of deposit (CDs) are a type of FDIC-insured savings account with a fixed interest rate and term.
- CDs come with specific term lengths, from three months to five years, in which the money typically can’t be accessed without paying a penalty. Generally, the longer the term length, the higher the interest rate.
- Some people implement a strategy called a CD ladder to optimize fixed interest rates and different term lengths.
- For people considering putting money into CDs, now is a particularly good time thanks to relatively high interest rates.
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Experts say the best place to save money is somewhere it can earn interest.
Putting your money in a high-yield savings account, certificate of deposit (CD), or money-market account can put hundreds or even thousands of extra dollars in your pocket in the long run.
While the stock market will often provide the best return on your money, it’s not a savings account. Money invested isn’t easily accessible and there’s a chance you may lose it.
The Federal Reserve increased its benchmark interest rate to a range of 2.25% to 2.5% back in December. As a result, online savings accounts with the highest APYs finally outpaced inflation for the first time in a decade, according to Bankrate’s chief financial analyst Greg McBride.
High-yield savings accounts have gained popularity over the last decade, as online banks offer increasingly competitive rates. The top high-yield savings accounts are currently touting annual percentage rates (APY) up to 2.35%, according to NerdWallet. Traditional savings accounts offer an average interest rate of 0.1%.
Meanwhile, the highest-earning CDs are offering 2.8% APY. Uncertainty around future rate hikes — or cuts, as President Trump recently called for — has increased the appeal of CDs for some savers.
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If you expect rates to fall in the future, locking in a high rate through a long-term CD now would be worth it. Or, if you expect rates to rise later this year, you could park your money in a short-term CD to take advantage of today’s rates, while maintaining the freedom to trade up if rates go up.
"This can be a good option for someone looking to park their cash for a short period of time and earn more than a general savings account," Anjali Jariwala, a CFP and certified public accountant at Fit Advisors, told Business Insider. "The nice part about a CD is there is no downside risk like you would experience with investing in the stock market."
Jariwala added: "The main trade-off with a CD is liquidity — you are tying up your money for a specified period of time."
CDs are a type of savings account with a fixed interest rate and time period ranging from three months to five years. When money is deposited in a CD, you lock in an interest rate that lasts throughout the term length — the longer the term, the higher the interest rate, generally. This can be highly beneficial when interest rates are high.
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"A few years ago, you might have been able to earn 1% on a 12-month CD, which didn’t seem like a good investment since your money is tied up for a year earning only 1%. CDs are now averaging 2.3% and more depending on the term you choose to invest," Jariwala said. Interest rates on high-yield savings accounts, however, fluctuate in accordance with federal rates.
Most CDs and high-yield savings accounts require minimum deposits ranging from $1 to $25,000 or more. At current interest rates, a $10,000 deposit in a high-yield savings account at Ally would earn $220 in interest after a year, assuming the rate doesn’t change, while $10,000 in a CD at Ally would earn $275. Interest earnings in both types of accounts are taxed as ordinary income.
Some people use CDs as part of a larger savings strategy to optimize fixed interest rates and different term lengths.
"I have a few clients where we are implementing a CD ladder strategy as a component of their fixed income portfolio," Jariwala said. "The CD ladder is broken up into four tranches — three, six, nine, and 12 months. As CDs become due, the money is reinvested into another similar term CD. If interest rates are rising, the goal is that you can pick up that higher earning CD when your current CD matures."
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While high-yield savings accounts impose a six-withdrawal-per-month limit — fewer than a traditional savings or checking account — taking money out of a CD before the end of the term will usually incur a penalty.
Because of these limitations, a CD may be a good place to store savings needed by a specific date and not anytime before then, Jariwala said, like money for a down payment or home-improvement project. If you’re worried about losing access to your money for a few months or years, then a CD may not be the best option for you. A high-yield savings account is often the best place for an emergency fund.
- Read more:
- How to invest $100,000 to make $1 million
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See Also:
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- 5 things to do now so you don’t have to think about money
- I paid off $40,000 of student loans in 2 years thanks to 3 smart habits
Source: Business Insider – tloudenback@businessinsider.com (Tanza Loudenback)