You may have a goal to begin saving more money. There are several ways to make the most of your savings, including opening a certificate of deposit, but are CDs worth it?
Certificates of deposit (CDs) are becoming more popular as the Federal Reserve continues to raise rates.
When the Federal Reserve raises rates, like they have several times in the past year, banks and credit unions tend to raise the interest rates of their CDs to remain competitive.
As a result, CDs have some of the highest yields of any other savings instrument.
If you are considering opening a certificate of deposit, you’re not alone. Many are looking at the rising interest rates and wondering if now is a good time to open a CD.
Keep reading to learn if opening a certificate of deposit (CD) is the right choice for your savings strategy in 2023.
What is a Certificate of Deposit?
A certificate of deposit (CD) is a type of savings instrument that requires you to leave your deposit untouched in exchange for a fixed percentage of interest on the principal.
Higher Interest Rates
These accounts typically offer a higher interest rate than traditional savings accounts because account holders are required to leave the money untouched for a set period of time, typically between three months and five years.
Personal finance gurus love CDs because they are deposit accounts that offer guaranteed returns. As long as you leave the money in the account untouched for the length of the CD term, you will be guaranteed a return on your investment in the form of interest on the principal. If you are looking for a low-risk return on a longer-term investment, CDs are a great tool to reach your savings goal.
CDs vs HYSAs
Many people confuse CDs with high-yield savings accounts. A savings account differs from a CD in that the account holder can deposit and withdraw funds at any point. A CD has a fixed principal, interest rate, and maturity date that play a role in the amount of interest that accrues and when the account holder can withdraw the money. If the account holder withdraws their money before the maturity date, they may be subject to early withdrawal penalty fees.
Rates Influenced by Federal Reserve
CDs are the talk of the town these days because their rates of return are influenced by the interest rate moves by the Federal Reserve. The Fed moved its rates several times in 2022, which means that banks and credit unions have moved their CD rates in response. We are seeing some of the best CD rates in recent years, which means that now is the time to act.
Types of CDs
Just like any personal finance product, there are different types of certificates of deposit to consider before opening one. Depending on the financial institution, you can choose from one of three CDs:
1. Standard CDs
Standard CDs are what we typically refer to when we talk about certificates of deposit. Standard CDs allow you to place a minimum deposit on an account with a fixed interest rate and term length.
When you open a new CD account, you will choose between a variety of term lengths, such as six months, one year, two years, or five years. Based on the term CD you choose, you will earn a fixed interest rate that will be paid out at maturity. The term lengths and interest rates offered will vary depending on the financial institution and interest rate environment.
If you keep your money in the CD account until maturity, you will earn the fixed interest rate. In many cases, the financial institution will give you the option to withdraw at maturity or reinvest the money back into the CD account. Depending on the financial institution, they may automatically reinvest the money if you do not specify that you would like to withdraw at maturity.
2. Specialty CDs
If savers want more out of their CD than a standard CD can offer, they can always opt for a specialty CD. Specialty CDs have features that set them apart from standard CDs. Different types of specialty CDs include:
- No-penalty CD: Savers will not be charged early withdrawal penalty fees if they choose to withdraw their money before the maturity date.
- Raise-your-rates CD: Also known as bump-up CDs, raise-your-rate CDs allow you to raise the rate of your CD once or twice during your term.
- Step-up CD: Step-up CDs automatically raise your rate when market conditions change and the financial institution raises its CD rates.
3. Brokerage CDs
Brokerage CDs are offered by brokerages rather than by banks or credit unions. Because they are bought and sold in secondary markets, they often offer higher rates of return than CDs offered by banks and credit unions.
However, they also tend to have higher minimum deposits than other CDs, sometimes as much as $10,000.
Pros & Cons
- Higher returns: Certificates of deposit offer higher returns than other savings accounts because you are promising to leave the money untouched for a set period of time. The rates will depend on the bank and the current interest rate environment, which happens to be very good at the moment.
- Safe and guaranteed investment: Once you open a certificate of deposit, you lock in an interest rate. This means that you are certain to earn a certain amount of money over the length of your CD term – as long as you don’t withdraw early.
- Principal is protected: The benefit of CDs is that you aren’t at risk of losing your principal investment. When you bank with a member FDIC institution, your deposit is FDIC-insured up to $250,000. Overall, CDs are one of the safest places to deposit your money.
- Early withdrawal penalties: When you open a CD account, you’ll have a variety of term lengths to choose from. If you withdraw your funds before the account matures, you could be subject to early withdrawal penalties, which could end up losing you money.
- Less liquid than traditional savings: The benefit of having a savings account instead of a CD account is that you can have easy access to your money. If you need access to your money in a CD account, you could end up facing fees for withdrawing early.
- Lower returns than stocks or ETFs: While CD accounts have higher returns than other savings accounts, their rates of return are typically lower than 4.00% APY. You could stand to earn more money by investing in stocks, ETFs, or other investment accounts.
Alternatives to CDs
Not convinced that CDs are the right product for your savings or investment strategy? Here are some other accounts that can help you store your money wisely.
Online Savings Accounts
Online savings accounts are similar to traditional savings accounts, but they often offer much better interest rates and fewer fees.
The reason online savings accounts are able to offer better interest rates than traditional savings accounts is that online banks do not have brick-and-mortar locations.
This means that they do not have many of the overhead costs of traditional financial institutions. In turn, they are able to offer better rates and fewer fees to their customers.
The drawback of online savings accounts is that online banks often only offer a few financial products, such as high-yield savings accounts. If you want your bank to house your credit cards, checking accounts, and more, this may not be the best option for you.
Money Market Accounts
Money market accounts are hybrids between a checking account and a savings account and often have better interest rates than checking accounts alone.
Money market accounts are touted as a safe and flexible way to store your money, especially if you need to be able to access your funds to pay bills and transfer money between accounts. However, these accounts can have withdrawal limits and may have less competitive rates than you would find with a CD account.
Student Savings Accounts
If you’re under the age of 25 and want to start building your savings, you may consider opening a student savings account.
Many banks offer student savings accounts as a way to help young people begin saving their money early on. These accounts can boast higher interest rates and fewer fees than standard savings accounts.
Keep in mind that your student savings account will likely be transferred into a traditional savings account once you reach a certain age, depending on your financial institution.
Are CDs Worth It in 2023?
Certificates of deposit are having a moment right now. With interest rates at a current high, there is certainly an opportunity to earn a relatively quick and easy return on your principal investment by opening a CD with your financial institution.
If you don’t feel that CDs are the right strategy for you, there are plenty of savings and investment options to consider. Be sure to chat with a financial advisor to identify the best strategy to help you reach your financial goals in 2023!
Frequently Asked Questions
How do CDs work?
To open a CD account, you need to make a minimum deposit into a CD account, which will earn fixed interest for a specific term length. The fixed interest rate, minimum deposit, and term length will be determined by the bank. If you leave the money untouched until the maturity date, you will earn a guaranteed amount of money.
Are CD rates going up or down?
Generally, CD rates are going up. As the Fed has continued to raise rates, banks, and credit unions have followed suit. In the past year, we have seen some of the best CD rates rise 3.5% APY (annual percentage yield) and above.
Are CDs a safe way to store my money?
CDs are generally considered a safe investment. They offer a required return on investment and require little involvement from the account holder. The vast majority of banks and credit unions are member of FDIC, which means the CD accounts are FDIC insured.