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
There are dozens of financial institutions, banks and credit unions — both online and physical locations — that offer CD investments. All CDs come with varying rates that usually depend on the length of the term. Some banks require you to hold a minimum balance in a savings account lest you face monthly charges. Sometimes there are charges for early withdrawals, and other times you have more flexibility to withdraw your money on short notice, similar to the flexibility provided by a savings account.
Other things to watch out for are automatic renewals, penalties, high minimum deposits and upfront fees. Some banks will even reserve the right to change your rate on short notice, so it’s important to read the fine print. And while it’s often true that you’ll find much better customer service if you already have accounts in the bank where you take out your CD, shopping around ensures you get the very best rates, the chance to cash in on CD specials, 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.
The best nationally available 12-month CD rates currently average 2.45% APY. With a short-term CD, you may be more tempted to withdrawal your money prematurely. But, if you want your money tied up for less than a year, this may be your best bet. If however, you don’t anticipate needing your money anytime soon and want to receive a slightly better rate than with a short-term CD, putting your money in a mid-term CD is a better option.
A long-term CD is a great long-term plan for saving your money. Plus, you get a stellar rate in return. Online banks and credit unions are typically your best bet for better long-term CD rates, with some now offering rates over 3.00% APY. But, make sure you can afford to put away your money for the long-term or incur penalties in the event you need to withdraw early.
3. Putting all of your money in a single CD
Higher interest rates offered with CDs may be tempting for investors, but knowing you don’t have access to your money for such a long time can be pretty unsettling. Putting all of your eggs in one basket may seem easier — just set it aside and forget about it. But, if you take out a five-year CD and need your cash early for an unexpected emergency, you’ll incur fees and penalties.
Putting your money into multiple CDs can solve this problem. For instance, instead of putting $15,000 into one five-year CD, put $5,000 each into a one-, three- and five-year CD. As your CDs mature, you can reinvest your money into a new five-year CD. Before long, you’ll have only one five-year CD earning the highest interest rate available. This way you have money available if you need it as your one-year or three-year CDs mature, giving you a choice to reinvest or not.
4. Putting the wrong money into CDs
If you want to save money and want higher interest rates than offered by most savings accounts, CDs are a smart choice. But, if you tuck away your money in a five-year CD — some banks offer CDs with terms as long as 10 years — and end up needing your cash, you may be looking at penalties for early withdrawal.
On the other hand, if you can afford to not use your money for five to 10 years, many financial advisors would tell you to invest in stocks instead. While CDs are low-risk, offering a fixed rate over a fixed term, stocks fluctuate in value. Stocks are best for investors willing to ride the tide of ups and downs but seeking long-term growth.
If you’re worried about putting the wrong money into a CD, another investment tool to consider is money market accounts. They deliver higher interest rates than savings accounts, but also often require higher minimum deposits. Interest rates are variable, which means they rise and fall with the interest rate market.
No matter which you choose, take a look at your history and how you spend or save your money before investing it for the future.
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.
Although your account will likely generate higher interest than a savings account for another term, it may not always be the best choice for your situation. There are other drawbacks. You have the risk of being locked in for an even longer CD term, which makes planning for the future more difficult. And the interest rate for your new CD is not guaranteed to be the same as the interest rate for your current one. Before you sign up, make sure your bank or credit union specifies if your CD is set to roll over automatically. If so, you may want to opt out.
6. Ignoring the Fed
When the economy slows down, the Fed may choose to lower interest rates. This encourages businesses to hire and invest more, and consumers to spend more freely. On the other hand, when the economy is growing too fast, the Fed may decide to hike rates, causing businesses and consumers to spend less.
Because banks often choose to lower APYs on CDs when the Fed cuts interest rates, yields will generally fall. Although they are getting harder to find, you can still get 3% yields on mid- and long-term CDs from some online banks and credit unions.
If you’re worried about earning the best interest rates on your CDs, look for five-year CDs with fixed rates and early withdrawals penalties of no more than six months worth of interest. But remember, banks start lowering their rates in anticipation of a cut, so if you see a good CD rate, take it.
7. Withdrawing money from a CD before it matures
When you invest into a CD, banks and credit unions pay interest on a regular basis, usually monthly, until your CD matures.
The longer you have your money in a CD, the more interest you earn. If you withdraw your money from your CD before it matures, you may have to pay the penalty, which could be several months’ worth of interest. For example, let’s say you have a three-year CD and you decide to withdraw after eight months. You might have to forfeit seven months of interest for early withdrawal. That leaves you with little in the way of a return on your money.
Before investing in a CD for any length of time, make sure you can afford to put away your money for the length of the term. Some CDs do allow penalty-free early withdrawals, but they usually come with lower rates.