Put Your Savings on Steroids with Certificates of Deposit
Published on - November 3rd, 2008 (Modified on - February 28th, 2012) (by J.D. Roth) High-yield savings accounts are great. They allow you to set aside money in a safe place to earn a respectable return. (That return is low right now, but will increase as the economy improves and interest rates rise.) But did you know you can put your savings on steroids by using a certificate of deposit?
Certificates of deposit (often simply called CDs), by definition are time deposits. You give your money to the bank and then promise not to touch it for a specific length of time. In general, the longer you agree to let the bank keep your money, the higher the interest rate you’ll receive.
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For example, here are the current rates from ING Direct (as of 16 November 2009):
- 6 month CD: 1.25%
- 9 month CD: 1.25%
- 12 month CD: 1.75%
- 18, 24, 30 and 36 month CDs: 1.50%
- 48 month CDs: 1.75%
- 60 month CD: 1.75%
By contrast, the ING Orange High Yield Savings Account currently yields 1.30%. Unlike a savings account, once you put your money into a CD, the interest rate does not fluctuate. If you open a 6-month CD at 1.25% and interest rates drop, you earn 1.25% the entire six months.
If certificates of deposit offer higher returns than a savings account, then why doesn’t everybody use them? The primary drawback to CDs is that they’re less liquid than a savings account; you can’t just move money in and out of them without penalty. You can take your money out of a CD before it “matures”, but you’re docked interest when you do. In fact, many (most?) banks penalize the interest amount, even if it isn’t earned (meaning you could lose part of your principle if you close your CD early).
Anatomy of a CD
I was fortunate to win a $1,000 6-month certificate of deposit from ING Direct recently. (I never win anything!) Looking at it might be instructive:
Looking at this screenshot, you can see that a certificate of deposit has an initial value (in this case, $1,000), an interest rate (3.50%), and a term (6 months). In other words, this is very much like a loan that I’m making to the bank.
You can also see that if I chose to redeem this CD early, I would sacrifice three months interest, whether earned or not. Because I’ve held the CD less than a month, if I were to break it now, I’d actually sacrifice part of my principal.
When this CD matures on April 9th, I will have $1017.28. Obviously $17.28 isn’t a huge return, but remember that interest rates are low right now. (Also consider that my $10,000 emergency fund were all in CDs, I would earn $172.80 in six months.)
Finally, it’s important to note that unlike a savings account, a certificate of deposit ends after a set amount of time. What happens at the end of the term depends on the arrangments you have (or have not) made with your bank. (See below.)
CD tips and tricks
Using a certificate of deposit is a great way to put your savings on steroids, but there are ways to make them even better. Here are a few tips and tricks that to help you get the most out of your money.
Use CDs to beat falling interest rates. When the Federal Reserve cuts short-term interest rates, you feel the pinch in your savings account. Certificates of deposit are a great way to buy yourself “protection”.
When you see a rate drop coming, open another CD. For example, the Federal Reserve just cut short-term rates another 0.50% last week. I would be shocked if banks didn’t follow suit, lowering the interest on their savings accounts. ING Direct could go as low as 2.25%.
When you see an interest drop coming, take some money from your savings account and throw it into a 6- or 12-month certificate of deposit, locking in the higher rate. (My web research hasn’t revealed what causes CD rates to move, but they do not move in lockstep with savings accounts.)
Climb the CD ladder. Just as you might 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 new 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. (Mrs. Micah has an introduction to laddering CDs at ING Direct.)
Protect yourself with parallel CDs. One of the biggest risks to your investment in a certificate of deposit is the need for early withdrawal. What if something happens and you need to pull the money out? As we’ve seen, this can be expensive. Nickel at Five Cent Nickel suggests mitigating your risk with parallel certificates of deposit.
Again, assume have $5,000 that you’d like to put into CDs. Instead of opening a single certificate of deposit for the full amount, consider opening multiple CDs. You might open three CDs at once, for example: two $1,000 CDs and one $3,000 CD.
This gives you a buffer in case you need to get at the money early. If you find you need $500, you can break a single $1,000 CD and the rest of your money is safe from penalty.
Beware auto-renewals. Nicole wrote last week because she was surprised to find that her certificate of deposit at Countrywide had automatically renewed at the maturation date. Many (most?) banks will do this unless you instruct them not to.
If you know you’re ready to pull your money out of a certificate of deposit, be sure to contact your bank to find out the proper procedure for doing so. Nicole found herself locked into another twelve month CD when she needed the money now. If she broke the contract, she would be forced to sacrifice 180 days interest, whether earned or not.
(Note that Nicole’s story had a semi-happy resolution. She knows to speak up when something seems wrong. Countrywide wouldn’t let her out of the CD entirely, but “I was able to negotiate a compromise to transfer the money to a 3-month CD, rather than the 12 month CD. Although the interest rate is lower, I will be out in 3 months, which isn’t too bad.”)
Shop around. As with any financial decision, it pays to shop around for CD rates. You may find that your local bank actually offers a better deal on certificates of deposit than the online banks.
For example, my local credit union only offers 0.35% on its regular savings account, but its CD rates are competitive with (and sometimes higher than) ING Direct. Since I keep my checking account at the credit union, it might make sense for me to hold my CDs there. (In this case, however, they’re not high enough to make me switch; I’d rather track everything in one place at ING.)
Here’s my list of current CD rates from online banks.
CDs in practice
I’m new to the certificate of deposit, but I can already see some uses for it. My $10,000 emergency fund, for example, is currently earning 2.75%. I may instead create a series of parallel CDs, as described above.
Also, I’m saving for my Mini Cooper. That money is also earning 2.75%. I’m nowhere close to buying the car, though, so I might as well put it into a certificate of deposit, too.
Though certificates of deposit are new to me, I’m sure that most of you have been using them for years. What tips and tricks can you offer? Do you have favorite sources for CDs? How do you decide which money to keep there and which to keep in a savings account?
This article is about Basics, CD Rates, Hints and Tips, Investing, Money Hacks
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My parents taught us about CDs when we were kids – I think I had one when I was 12. Then I forgot about them until just recently, and I opened two CDs with ING. I made a mini-ladder without even knowing what I was doing; it just seemed smart to me to put some in a 6mo and some in a 12mo, given the balance between better interest and a need for liquidity. Now I know about ladders, I think they’re cool!
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Barry: I’m not sure if they already reflect the current Fed 1% interest rate. If so, I doubt they’ll go much lower, but still better to get your interest going early.
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kitty: thanks for the information on interest. I am going to look into some of those!
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CDs are a horrible investment device. And worse for an Emergency Fund. What happens when that emergency comes along and you need access to your money? Now instead of easily pulling the money out of the bank, writing a check, or pulling out of the ATM you have to go through the trouble of cashing them in, losing money earned and maybe even some of the original money because the “expected” emergency happened. Bad, bad idea.
Besides, if you have a good credit union you can earn more than 4% interest on a basic checking account. I currently earn 5.25% on mine.
My point is why risk any of your money at all on crap CDs when there are other (and not to mention more liquid) ways to earn the same or more interest. Doesn’t sound smart to me.
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CD ladders are an awesome way to put away and grow your money, if you’ve already got an ‘emergency fund’ in place. You’re going to have access to at least some of your money every six months, and during that time you’ll be earning a much better interest rate than high yield savings accounts.
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I also have a cd ladder going for my emergency fund. I started out setting up a 3 month, 6 month and 12 month cd every month until I had one maturing each month of the year. As they renew I’m converting them all to 12 month cds. So every month I have access to part of my emergency fund. Right now I have amounts ranging from $50-$500, but I’m first bumping them all up to $500 and eventually want to get them all to $1000 so I can pay all my basic needs for a year even if my fiance and I both lost our jobs. It also keeps us from touching the emergency fund unless it’s really an emergency.
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Bill: I don’t know how it is at other banks, but ING CDs you just click a button that says redeem early, and that’s it. The penalty for withdrawing early is 3 months interest. That’s it. It’s a very small penalty for an emergency if my 3-4 months liquid reserve doesn’t cover it.
If I had an emergency where I didn’t have time to log in, click the redeem early button, and write a check, I’m probably being held up and it would be a good thing the CD money is inaccessible.
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CD’s are not the best option for short-term funds. Depending on the amount you invest, the (if it is only 10k or so) it probably isn’t worth it. If you should need the money early a lot of times there are fees attached. Plus that same 10k at 6-months or a year at 2.75% compared to 3.5% is not that much of a difference. One upside to most of these fees is that they are usually tax deductible, but you still lose money. I agree with Bill that there are more liquid ways to earn the same interest.
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To each their own, of course. I have a years worth of emergency savings – 3 months worth in liquid funds. I can’t foresee that I would need all of that upfront. If something happened to my job, I would be guaranteed my CDs would mature at intervals where I could pay my bills – like getting a salary or loan from myself. If I lost my job, it would guarantee that I would have to budget my money until the next CD matured. By then, I would have hoped to have a new job. But if not, I’m covered.
I guess it’s sort of like freezing credit cards for some people. If half my emergency fund is locked away in untouchable funds, then it prevents me from thinking, “Ooo I can buy that new Macbook!”
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I rarely brag about being deployed to Iraq, just because it’s not that much fun, but after 30 days in a combat zone, servicemembers can put 10K in an account (called the Savings Deposit Plan) that makes a gauranteed 10% interest. It will continue earning interest for 90 days after we return from the combat zone.
There is no CD rate better than this! Any servicemember who does not take advantage of this account is throwing money away.
Your tax dollars at work, and I for one appreciate it!
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I feel so alone here. No CDs on my ING account. Now I have a New Year’s resolution for once.
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Adam. CDs are similar to fixed rate accounts in the UK. Some good rates at the moment, Anglo Irish Bank Corporation International) Privilege Fixed Interest account 7.21% for 12mths. Much better rates than the average UK savings acoount. I just opened a Halifax International regular saver account which is 10% for 12 months.
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Someone else said to check your local credit union. They don’t always have better CD rates but at my credit union they have 5% on a checking account up to $15k.
I have a checking account that I opened at another bank to get $100 bonus. no minimum and I just need to have at least $250 a month in direct deposit. We use this account to build up savings to pay for our life insurance (2x a year) and our propane that we pre-buy in May for a discount. What I do is take that $$ out each month (leaving only $100) and deposit it in my credit union at 5%. But I don’t add it to my software program that I track our accounts. I keep a separate ledger for that money in there. I can see the true balance online when I pay bills, but I follow my program as the “balance”. Then when I need that cash I can get to it.
This kind of tricks me into not having it on the books to spend on other things while still earning 5%.
Kind of silly but it works for me.
I do have a couple of CD’s that were set up for me in an IRA account. One is at 5.01% and will mature in 2010 and the other is at 2.5% and matures in May. Since these are in an IRA account I just keep rolling them over.
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It seems to me the folks who are protesting sticking EFs in CDs are people who are thinking of traditional CDs and traditional dollar amounts.
INGDirect really does make it simple to yank the cash, as I found out earlier this year when I needed to buy a new computer (yes, a computer is a need in my world). I closed six seperate CDs to and lost about $1.75. I had laddered CDs, and they were all in small dollar values, currently my biggest CD is $252.60 and most are in the $50 range, because that is how much I put towards my EF every pay period.
As I stated before, I have used INGDirect’s incredibly simple new account setup to go from a negative checking balance to no consumer debt and a one-month EF in 11 months. It works for me, but that doesn’t mean it will work for your situation.
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Bankrate.com has an excellent CD laddering calculator that will tell you when and how much to invest in a ladder based on your goals.
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Re: using CDs for emergency cash. Given 12 CDs, one maturing every month, my plan (should the need arise) is to either use a CD to cover the emergency expense if the expense occurs during the grace period (my CDs have a 10 day grace period during which I can either withdraw without penalty or roll over) or use a credit card to cover the expense and use the next maturing CD to cover the full credit card payment. My goal is to have 12 CDs of $2500 each. If an emergency occured requiring more than $2500, I would assume the magnitude of that situation would dwarf any concern I would have about losing some interest by breaking into a second CD.
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Unlike most CDs on the market, Washington Mutual’s CDs actually do include an “Add-On” feature: once the CD has been set up, you are allowed to make additional deposits at any time during the term, up to the amount of the original sum (for example, if you open a CD with $2500, you could deposit up to $2500 more, for a total of $5000). The additional deposits earn the same interest rate as the money used to open the CD, and all the money is available to you at the end of the term, whether or not it’s been held in the CD for the full time period. This is a nice incentive to put a little extra cash aside, if you don’t think you’ll need the money too quickly. WaMu has also been known to offer great limited-time-only promotional rates which come and go without warning (currently branches, but not the website, are advertising a 3.51% APY on 9-month CDs, $1000 minimum to open); opening a CD and continuing to make deposits at the CD rate could be a good buffer strategy against sinking interest rates. (Every bank probably needs cash right now, even if they don’t offer the Add-On feature, so keep looking for good deals!)
A word of caution: the Add-On feature might not survive Washington Mutual’s eventual takeover by Morgan Chase, but a bank employee told me this week that all terms and rates outlined in current WaMu CD agreements will hold to the deposits’ maturity.
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This is a great post, one that explains the basics of CDs, which most people are not familiar with.
The main point to remember is that it’s not liquid for the term, but you are locked into a potentially great interest rate. It’s not entirely ideal to put your whole savings into CDs; if you have an emergency, you have to pay penalties! But if you have a good amount that is laying around and you don’t want to risk putting it into investments that could potentially lose value, then this is a good product to have knowledge of.
Also know that it’s a deposit product that is FDIC insured at member banks. So know your FDIC insurance rules as well.
There are other special CDs already mentioned in the comments that allow you to make additional deposits or make partial/full withdrawals with no penalty. Some of these require minimum balances or requirements, but it’s always good to know your options.
Also as an insider tip from someone who works for a bank, it pays to rate shop sometimes. Not sure if this applies to all banks, but where I work we have rate calculators that helps us make VERY competitive offers that are not usually promoted; very short term with really good rates. Just tell your banker what you are looking for and see if they can get approval from upper management. You’ll probably need a high balance though (sometimes $10,000+). But again, it never hurts to know your all your options!
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“My $10,000 emergency fund, for example, is currently earning 2.75%. I may instead create a series of parallel CDs, as described above.”
Did you end up doing that, JD? I’m considering it, but I’m concerned about liquidity, given the nature and intent of an emergency fund.
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Dustin, I did not do the parallel CDs, but I still may sometime in the future…
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In addition to an Add-On feature in order to attract interest in CDs some credit unions have gone to a bump feature. The ones I have seen are longer than 18 months. At some point after an initial period, usually 6 months on an 18 month CD, you are allowed to adjust your interest rate. Therefore if you invested in a CD at a very low rate of return, say 2%, and in 6 months rates are now 3.5%, you are allowed to bump up to at least a portion of that improved rate, sometimes the entire improved rate. I have not seen this on many CDs, but in low times it might be a good idea, since an investor may miss a good period of growth, but can still bump their CD if they are watching interest rates.
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about how many have “certificate deposit” today?
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I have yet to see anyone speek about using a CD ladder for/in retirement.My plan is to begin to pull my IRA funds approx.,1 year before retirement and set up 12 each CD’s worth 25k each.These would be in three seperate banks/credit unions to assure FDIC backing, for a total of 300k.I will repeat this with my wife’s IRA the year before she retires and sell our home and add an additional 300k to put monthly in CD’S. This will bring three $25K CD’S ($75K)to maturity each month at what ever interest rate they were purchasted at.So @ 2.5% this would be $1,875.00 per month income plus two social sec checks,one pension,and a small house valued at approx.,$300k.Please let me know if you see any flaws in my plan as I am not a pro at this and I do want to have all my $$$ in safe place so that what just happened in the USA will never get me in my retirement.Looking forward to all your comments……… thanks-soooo much pat
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