So you’ve moved on from traditional savings accounts and certificates of deposits have piqued your interest. But there’s gotta be a savings option that gives you better returns, right?
With the best one-year CD rates currently offering .70% annual percentage yield (APY), you might feel comfortable with the modest return and low risk.
But in today’s environment with the COVID-19 pandemic and the Federal Reserve dropping interest rates, CDs are offering minuscule returns with the potential to drop below zero if you take inflation into account.
So why not take control of your personal finances and look into options that give you a higher APY? In this article, we give you an overview of CDs and the more favorable alternatives.
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What are certificates of deposits?
A certificate of deposit is a type of debt obligation issued by banks, credit unions, and brokerage firms where you’re locking in your money for a fixed amount of time in exchange for earned interest over that period.
They’re popular for those who want to earn more on their savings than a traditional savings account, but don’t want to take on the risk or volatility of the stock market.
How it works:
When opening a CD account, you agree to certain terms such as the interest rate, the term length of your deposit, the principal amount deposited, and the specific requirements of the institution of your account. Which includes early withdrawal penalties and possibly special promotions.
The higher the term length, the higher your APY return will be. Some can go 0.50% over a six-month term while others go as high as 1.10% over five years.
But in general, it’s a popular option because it’s safe (FDIC insured), low maintenance, has short-term liquidity, and typically offers a higher interest rate than standard savings accounts. So it’s not a surprise why many people choose them.
Key facts on CDs
Opening a CD is very similar to opening standard bank deposit accounts. Once it’s established and funded, you’ll typically receive monthly or quarterly statements as well as interest payments per statement cycle.
You must initially deposit a principal amount when you open a CD. But luckily, CDs usually don’t charge a monthly maintenance fee like savings accounts and money market accounts.
You must lock in your deposit for a fixed amount of time (e.g., 6-month CD, 1-year CD, 5-year CD, etc.) to avoid early withdrawal fees. At the end of the term when your CD has fully “matured,” you can withdraw your funds penalty-free along with your earned interest.
They are completely low risk with a guaranteed rate of return, being FDIC insured.
Interest rates are largely dependent on the principal deposit amount and CD term. They’re typically better than traditional savings accounts and money market accounts. But in general, the longer the term the better your annual percentage yield is.
Disadvantages of CDs
The Federal Reserve has made it clear they intend to hold rates at historically low levels for an extended period of time. And if it does unexpectedly rise at some point, you’re already locked in with a fixed interest rate and term period. All the while you are still getting taxed on your CD-earned interest income.
Couple these factors with rising inflation, which means you might actually end up losing money on your rate of return.
In addition, CDs lock you into a term period so you can’t access your funds early without paying fees. And without liquidity, you have to be absolutely sure you won’t need those funds in the near future.
