CD Investment: A Safe Haven for Your Savings (and How to Maximize Returns) (2024)

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• A certificate of deposit is a type of savings account with a fixed interest rate and term.
• CDs are a safer investment than stocks and certain types of bonds.
• An early withdrawal penalty may apply if you cash out a CD early, but your principal stays intact.

Experts say the best place to save money is somewhere it can earn interest. While the stock market often provides the best return on your money, it's not a savings account. Money invested isn't easily accessible, and there's a chance you will lose it.

Putting your money in a certificate of deposit (CD) can keep your investment safe and put extra money in your pocket.

What is a CD?

Definition and how CDs work

CDs are a type of savings account, and aren't typically considered investments. CDs are a low-risk place to keep your money and pay lower returns in comparison to investing in the stock market.

Most CDs come with a fixed interest rate and terms that typically range from three months to five years. When money is deposited in a CD, you lock in an interest rate that lasts until the maturity date. The best CDs are currently offering over 5% APY for 18-month to 3-year terms.

Benefits of CD investing

One advantage of CDs is predictable growth. CDs earn a fixed rate of return, so you know exactly how much you'll get over the CD term when you open it.

Additionally, your money in a CD is secure because it's in an FDIC-insured bank account. Up to $250,000 per depositor is covered by FDIC insurance. In the unlikely event of a bank failure, you'll recover your savings. NUCA insurance covers CDs at credit unions, where they're called "share certificates."

Drawbacks of CD investing

The main downside of a CD is the lack of liquidity. Most CDs require a minimum deposit, from $1 to $25,000 or more, and you typically can't add money to the CD once the term begins. If you dip into the account before its maturity date, you will usually face an early withdrawal penalty that's equal to some of the interest you've earned so far.

Some may also consider the relatively low interest rates a downside. Compared to stock market investing and some bonds, CDs may earn a lower rate of return. CD returns are also unlikely to keep up with inflation over the medium or long term.

Types of CDs

There are several types of CDs that may be right for unique goals and financial situations. Common ones include:

• Traditional CD: These pay a fixed interest rate for a fixed period of time. If you want to withdraw money before maturity, you will face a penalty.
• No-penalty CD: These don't charge a penalty for early withdrawals, but typically offer a lower interest rate.
• Jumbo CD: For deposits of $100,000 or more.
• Callable CD: The issuing bank can decide to end the contract early and pay you any interest earned up to that point.
• Bump-up CD: The bank lets you request at least one rate increase during your term.
• Step-up CD: The bank grants one rate increase during your term, the size and timing of which is pre-determined at account opening.
• IRA CD: A CD purchased through a traditional, Roth, or SEP IRA that adopts the tax treatment of the overall account. Funding limitations apply.

Where to find the best CD rates

Online banks and credit unions typically offer more competitive rates than traditional brick-and-mortar banks. Still, you'll find the best CD rates by comparing offers for the same term lengths from multiple types of institutions.

Strategies for maximizing your CD investment

If you expect rates to fall, locking in a high rate through a long-term CD could be worth it. If you expect rates to rise, 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 increase.

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," says Anjali Jariwala, a CFP professional and CPA at Fit Advisors.

"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."

Laddering is also helpful for those who want access to their money at regular intervals rather than locking up a large sum, but would like to earn more than savings accounts are currently offering.

Factors to consider before investing in CDs

Minimum deposit

Most banks have a minimum opening deposit ranging from $1 to $2,500 for traditional CDs or $100,000+ for jumbo CDs. Different amounts may pay different rates, so be sure that you understand what the financial institution is offering.

APY

If growth is most important to you, then you'll want to find a CD paying an APY at or above the current inflation rate. Remember that your rate is guaranteed for the timeframe you choose, as long as you don't make an early withdrawal.

Term length

Carefully consider your purpose for the money you're investing and match the CD's maturity date with that timeline. If you're unsure when you will need the money, choose a shorter term or opt for a no-penalty CD. If you're willing to stomach some risk, consider bonds or stocks instead.

Tax implications of CD investing

CD interest and taxes

Interest earned on CDs must be reported on your tax return annually because CD interest is taxable as ordinary income. Unless you have a significant amount of money invested, CD interest likely won't have a big impact on your tax bill.

Tax-advantaged accounts

There's one way to get around owing taxes on your CD interest each year, and that's by holding a CD in an individual retirement account (IRA). With an IRA CD, your interest earnings are tax-deferred or tax-exempt, depending on the type of IRA you open. However, you don't have access to your initial deposit or your earnings until age 59 1/2.

Is CD investing right for you?

Because of the early withdrawal limitations, a CD may be a good place to store savings needed by a specific date and not before then, Jariwala says, like money for a down payment or a home improvement project.

If you're worried about losing access to your money for a few months or years, a CD may not be the best option for you; a high-yield savings account is often the best place for an emergency fund.

When you can afford to weather some volatility, a brokerage account or retirement plan where you can buy securities that have the potential to earn a greater return is usually best.

CD investing FAQs