When you open a CD, you deposit money with a bank and promise not to touch it for a certain period of time. Terms generally range from three months to five years. The longer you agree to let the bank use the money, the higher your rate of return. My credit union currently offers rates of between 4.30% and 4.90%, depending on the term.
However — and this is a big however — a CD is not as fluid as a savings account. Once you open your CD, you cannot touch your money until the maturation date. If you do, you’re subject to significant penalties that can conceivably eliminate any earned interest.
Returns on CDs aren’t spectacular, but they’re safe, sure investments. And in a period of rising interest rates, CDs become more attractive. A reader at CNNMoney says:
I’ve been pleasantly surprised at the recent rise in interest rates for CDs. What is the best way to evaluate the potential for CD rates to increase, and how do I know when it’s a good time to lock in a rate rather than waiting for rates to go up still more?
Money expert Walter Updegrave says that, as with playing the stock market, it’s really not possible to second-guess interest rates. But just as you can use dollar-cost averaging to profit from fluctuations in the stock market, you can use a “CD ladder” to profit from fluctuations in interest rates.
Say you have $5000 to invest. To build a CD ladder, you would invest the money in CDs with staggered maturation dates:
- $1000 in a one-year CD
- $1000 in a two-year CD
- $1000 in a three-year CD
- $1000 in a four-year CD
- $1000 in a five-year CD
As each CD matures, you immediately invest your money in a five-year CD, effectively maintaining the one-year stagger, or ladder. You won’t earn the best possible rate of return, but you will earn a good one, and your income will be relatively constant. The CD ladder is also a form of diversification: you’re not betting all your money on one interest rate.
I haven’t invested in CDs yet, but I suspect I will before this year is out.
For more on certificates of deposit, read how to build a CD ladder and how to manage a CD ladder in a low-interest environment at FiveCentNickel. Here’s a CD ladder calculator you can use to play with numbers.
You can also check the table below to compare who is currently offering the highest CD rates.