5 smart moves for investing in CDs

Although CDs haven't risen as much as we'd hoped since the Federal Reserve raised interest rates in December, we could soon be in for a second boost.

A majority of Fed watchers predict the next rate hike will be announced in June, July or September, which is certainly not the pace the Fed had been forecasting in 2015, when it indicated one hike per quarter was likely this year.

But though the climb will be more gradual than we'd all anticipated, even a slow upward movement in rates over the next few years means CD savers need to be savvier than ever in choosing their certificates — and their timing.

These best practices will help you squeeze every drop of earnings you can out of your certificate of deposit investments, no matter how quickly or slowly rates go up.

Smart move 1. Time your purchases to the Fed.

Paying attention to the Federal Reserve's rate-setting calendar should help smart savers lock in higher new returns after a rate hike, rather than getting stuck with a lower rate right before one.

That's because bank deposit rates are typically linked to the federal funds rate, which is the interest banks pay to borrow money from the Fed.

When the Fed raises that rate, what banks offer to pay savers for their money also increases.


From December 2008 until December 2015, the Fed's rate-setting committee held the fed funds rate near zero to stimulate an economic recovery after the financial crisis, and bank deposit rates tanked to historic lows.

With the economy finally throwing off sufficiently strong and stable signs of health, the Fed launched its planned series of hikes that aim to gradually "normalize" banking rates again.

Originally the Fed had projected it would raise the fed funds rate about a percentage point a year, until it reached 3.5% over the next several years.

But in the months since the inaugural hike in December, global instabilities, rock-bottom oil prices and still-lacking signs of healthy inflation have all weighed on the Fed's willingness to further boost rates.

The only other time we can look at in Fed history for an exceptionally low period that was raised methodically was back in 2003. At that time, the federal funds rate had been held at 1.00% but was increased to 3.50% over the next two years.


When the fed funds rate was 1.00% in 2003, the average 1-year bank yield was 1.26%, and the average 5-year yield was 3.02% APY.

After increasing the fed funds rate to 3.50% by 2005, the 1-year CD average had climbed to almost 3.00% APY and approached 4.00% for the 5-year average.

It's a far cry from today's national averages, which are just 0.29% and 0.83% APY for 1- and 5-year CDs, respectively.

Of course, no one (including the Fed) knows how banks will respond this time around, because the seven-year valley — as well as the Fed's much slower, more gradual plan to boost rates in this new era — simply have no precedents.

But what savvy CD savers do foresee is that, however frequently the Fed raises rates, it's best to be aware of the calendar for potential hikes to be able to lock in new CD rates after, and never before, a Fed rate hike.

Smart move 2. Favor short- and mid-term CDs or those with easy exits.

When you choose a long-term CD — such as four or five years — you do so to earn a higher rate. But if we enter a period of increasing yields, that choice has a significant downside.

Not only will you be locked in at today's returns in the later years of your CD, after yields have been on the rise for the first few years, but the cash stashed in your long-term CDs won't be available to deposit at new, better rates when they start becoming available.


That's why the smart move today is to focus largely on short- and mid-term CDs, ideally up to three years in length.

If you find yourself unable to resist an attractive long-term rate, only do so if the bank or credit union's early-withdrawal penalty is reasonable.

At a typical six months' interest, incurring the penalty can be a smart financial decision in exchange for making your funds available for a new, higher-rate CD.

But if the penalty is more onerous — some banks charge 12 months' interest or more, or even assess a penalty that can cut into your principal — look either to a long-term CD with a milder penalty or to a shorter-term rate.

To find out these policies for all of the top-paying national banks, see this quick-reference chart on the best and worst early-withdrawal penalties.

Smart choices on maturity length aren't the only consideration, however. When looking at short-term CDs, never lock in your funds at a rate less than you can earn with the nation's top savings and money market accounts.

Some online savings and money market accounts currently pay up to 1.60% APY, so use them to your advantage to store money you would otherwise have put into a short-term CD or want to keep available until CD rates start climbing.

Smart move 3. Diversify three ways.

It's sage advice throughout the investing world: Diversify.

When it comes to smart CD investing in a period of potentially rising rates, there are three important ways to divvy up your deposits.

First, you'll want to diversify across terms, or maturity dates. The conventional way to do so is a strategy called laddering.

When you build a CD ladder, you buy an assortment of certificates in increasing terms, which provides you with a regular supply of maturing CDs that can be reinvested at the current highest returns.

Second, today's potential for rising rates makes it useful to diversify your investment dates.


One way to do this is to set up not a single ladder, but multiple ladders that begin at different dates as Fed rate hikes arrive.

You could start one ladder soon after the first hike, then another three or six months later and then a third ladder 3-6 months after that.

Doing so always leaves you in a position to capitalize on the latest Fed rate increase, while simultaneously making maturing funds frequently available to invest at future (presumably higher) rates.

Lastly, for those investing $250,000 or more in deposit accounts, it's important to diversify across banks.

That's because federal deposit insurance is capped at $250,000 per depositor per bank. Invest in CDs in four banks instead of one, and your FDIC insurance coverage increases to $1 million.

Smart move 4. Shop around.

Although buying CDs from the bank where you already have your checking account is convenient, it's unlikely to be your smartest financial move.

In fact, the savers who glean the most earnings from their cash almost always do so with a veritable stable of financial institutions, creating a diverse portfolio of the highest-paying offers.


Dozens upon dozens of national banks, credit unions and community banks offer CDs paying three, four or even five times more than the national average returns, so there's no excuse for settling.

Take, for instance, the top nationally available 3-year CD, which currently pays 1.75% APY. The national average on 3-year returns? An anemic 0.54% APY.

Although there are some consistent leaders in CD rates, it is common for institutions to stagger their offerings, meaning they might offer a chart-topping 2-year return today, but then shift to a top-paying 5-year CD next quarter.

That means shopping for the best 1-, 2- and 3-year rates might lead you to three institutions instead of one and quite likely not at your regular bank.

Bankrate's extensive database of the best local and national CD rates is a good, easy place to start.

Smart move 5. Vigilantly reinvest every maturing CD.

Anyone employing these smart tactics will find themselves with CDs maturing at staggered times throughout the year.


To maximize your returns on a perpetual basis, be sure to reapply all of the recommendations above to the funds freed up by each maturing CD.

Letting an existing bank roll over your maturing CD into whatever new certificate it deems appropriate can significantly hamper the yield of your overall CD portfolio. That's because it's highly unlikely the CD chosen for rollover will be the best option for the term when you shop around.

After seven years of dismal rates, CD savers will hopefully be looking at much stronger earnings over the next few years. And those who make the smart moves above will be rewarded most of all.