Mistakes To Avoid When Investing In CDs

Point of Interest

Avoiding mistakes when you purchase CDs lets you maximize your return on investment while allowing you to build flexibility into your portfolio.

Certificates of deposits (CDs) offer investors competitive interest rates and typically higher APYs than conventional savings plans, letting CD investors sit back and watch their investment grow. Another key advantage of investing in CDs is that the FDIC insures deposits at member banks and credit unions up to the maximum amount allowed by law. However, as secure as a CD is, there are some common mistakes to avoid that could cost you thousands.

Avoid these 7 costly mistakes to maximize your CD earnings

1. Not shopping around for the best CD rate

You’ll find a great range of CDs available from financial institutions today — but they differ in important ways. APYs aren’t standard, and usually depend partly on the length of the CD term. You’ll want to check current rates and minimum deposits, but also be aware of charges for early withdrawals, automatic renewals, penalties, upfront fees or other requirements that can limit you and cost you money. 

Be aware that some banks reserve the right to change the rate on your CD investment on short notice — it’s important to read the fine print. Shopping around ensures you’ll find the best vehicle for your money with great rates, loyalty rewards and more. 

2. Choosing the wrong CD term

With CDs investments, you are stashing away a specific amount of money for a set period of time without touching or spending it. In return, you earn higher interest than with a conventional savings account. The trick is determining if you want your money in a short-term CD fewer than 12 months, in a mid-term CD between one and three years or in a long-term CD over three years. Choose wrong, and you may be looking at early withdrawal penalties that soak up any interest you may have earned.

Most 12-month CD rates are currently averaging 1.50% APY. Long-term CDs, like 60-month cd rates, are closer to the 1.75% mark if you’re willing to put some money away for 5 years.

3. Putting all of your money in a single CD

If you’re worried about not being able to access your money in an emergency, consider placing it in several CDs with different maturation rates, rather than all in one. For example, if you have $15,000, put $5,000 each in a one-, three- and five-year CD. When each one matures, you can roll it into a new five-year CD with a different maturation date, knowing that every two years, one of your CDs will mature and provide you with funds you can use or reinvest. Once all your money is invested in longer-term CDs, you’ll also earn significantly more interest than you would with shorter-term options.

4. Putting the wrong money into CDs

CDs aren’t the only vehicle for letting your money work for you. If you can afford to commit your money for five or 10 years, many advisors suggest you consider stocks. One factor is how comfortable you are with risk. CDs are low-risk, with a fixed rate that’s guaranteed. Stocks may rise or fall significantly, and you’ll need to ride the ups and downs while waiting for long-term growth.

Another investment tool is money market accounts, which are very similar to a savings account, but usually require very high minimum deposits. You can still withdraw money from a MMA without penalty, but typically cannot let the balance fall below a certain threshold. If you believe you’ll need the money before the end of a CD term, try a different investment method instead.

5. Letting your CD automatically roll over

One of the most costly mistakes people can make when choosing a CD is failing to read the small print where it says your CD will automatically roll over at maturity. Your money, including the original deposit and any interest earned, will be rolled over into a new CD account for another predetermined term.

There are other drawbacks. You might not be eligible for the same interest rate with the new CD, and you risk being locked into another CD term you might not want. Before you sign up for your CD, check and see what the institution does at the end of the CD’s term — and consider opting out if that does not fit your plan.

6. Ignoring the Fed

In a slow economy, the Fed may lower interest rates to spur growth. If the economy is growing too fast, however, the Fed raises rates, which causes businesses and consumers to spend less. When the Fed cuts rates, banks lower APYs on CDs, and your interest earnings will fall. So it pays to watch the Fed and open CDs during periods when rates are higher.

7. Withdrawing money from a CD before it matures

When you open a CD, you promise to leave your money in the bank for a designated period of time. If something comes up and you need to withdraw that money, you’ll pay a penalty, which is usually several months’ worth of interest, or more. CDs that allow penalty-free withdrawals generally come with lower interest rates. Depending on the type of CD term, withdrawal penalties can range from 60 to 365 days of interest so make sure to factor that into your plans when taking opening a CD.

The final word

CDs offer a low-risk vehicle for earning money through competitive interest rates. They’re especially useful if you can afford to have your money tied up for several years. But not all CDs are created equal: by shopping around, you can find the best rates, along with a term period that works for you. Investing in multiple CDS with varying interest rates is a great way to have access to your money at regular intervals, which you can do by laddering your CD maturation dates.

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