Should I Use a High-Yield CD for My Savings?

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I’m Laura Adams, your host and personal finance author, speaker, and consumer advocate. Who’s been producing the show since 2008. My personal mission and the purpose of this podcast is to give you the knowledge, resources, and motivation to manage your money the best way possible and create a richer life. If you haven’t been to the money girl section [email protected], that’s where you can find the show notes, the complete archive of podcasts, all my books, and many other great resources. Today is episode number 638 called should I use a high yield CD for my savings? And we’re going to kick it off with a recent voicemail that I received from Anna in Washington, DC.

Hi Laura. This is Anna calling from Washington, D C thanks for putting out a great show. I’ve been listening to your podcast for several years and your straightforward advice and information has helped me make good money decisions. I share your work with everyone. I know here’s my question. I keep a majority of my savings and a high yield savings account that at one time offered a 1.7% APY on my savings. However, due to the federal reserve lowering interest rates in response to the economic impacts of the COVID-19 pandemic, I bank recently reduced the rate. They offered to customers to 1.5, 5%, and now even less at 1.3% APY, this is obviously frustrating for me as a customer, but I understand that a lot of this is outside of anyone’s control. And these trying times, however, this financial institution is offering for customers to use a CD, which earns a 1.5% APY.

This seems attractive given the additional boost. However, I’m not really sure what the pros and cons are for CDs. And to be honest, I’m not exactly sure what a CD is. If it’s helpful for context, I keep my six months emergency fund savings in this high yield savings account. And I’m trying to save for a down payment on a house. I of course want my emergency fund to be readily available given these uncertain times, but I probably won’t need to touch, buy down payment savings for at least another year or two, or maybe more since the housing market is very expensive in the DC area is moving my money to a CD. Makes sense. Or should I just keep it in the high yield savings account and wait for the feds to raise interest rates after the pandemic and hope that my savings account rate will eventually increase again. Thanks so much for your time. I look forward to hearing your response. Bye bye.

Thanks so much for your kind words and very thoughtful question, Anna, in this podcast, I’m going to answer it by explaining what a CD or certificate of deposit is and how to use one wisely. You’ll get an overview of the different types of CDs and learn the best places to find high yield CDs, if they’re right for you. So let’s first cover what is a CD and it’s a financial product. It’s offered by many different types of financial institutions, including banks, credit unions, investment firms, and insurance companies. It’s really different from a savings or a money market deposit account because you give up access to your money for a period or a term. So in exchange for agreeing not to touch your money during a CDs term, you typically get more interest than you would with other types of deposit accounts. A CD gives you a guaranteed return.

That’s the upside and you get that return no matter what happens to the economy or in the financial markets. And there are two ways to measure the interest that you get for a CD. One is APY and there’s APR. So APY stands for annual percentage yield. This is the rate that you receive. If all the interest that you earn on the CD gets added back to your balance, which is called compounding. So in other words, AP wise, the rates you get, if you never withdraw interest from a CD APR, which stands for annual percentage rate, that’s the rate of interest that you earn without taking into account the effects of compounding in a year. So it’s the rate that you get. If you did withdraw every penny of interest and you didn’t have any compound growth in the account. And if you see a CD rate that doesn’t say, if it’s APR APY, you should assume that it’s the APR.

Now, if you purchase a CD that comes with FDI C insurance, that stands for federal deposit insurance corporation that comes from banks typically, or N C U a, which stands for national credit union administration insurance that comes from credit unions. Obviously, if you buy a product that gets either type of coverage, you are covered for up to $250,000. If the institution fails for just about any reason. And that two 50 includes not only your principal, but your interest in the account and some institutions that are not banks, such as insurance companies will offer CDs with FDI C insurance. So you don’t have to go to a bank or a credit union to get a CD that comes with insurance, but there are some CDs out there that don’t come with insurance. So be sure to check the minimum amount required to open a CD is generally $500, but it could be much higher depending on the institution and the type of CD that you buy.

And you can put an unlimited amount of money into a CD, but to be safe. What I recommend is that you always stay under the FDAC or the NCU, a limit that I just spoke about the $250,000. And that limit is per account holder per institution. So if you’ve got more than $250,000, you might want to spread it out at different institutions. So let’s talk about what the downsides are of getting a CD that, you know, the upside is. I mentioned as a guaranteed return, the downside is that your money is locked up for a specific term that might range from a few months to maybe five years. So you get to choose the term when you’re purchasing the CD. And when that term ends, you get back your principle. Plus the accumulated interest CDs with longer terms, generally yield the highest interest rates. However, if you need the money and you need to withdraw money from a CD before it expires, and that expiration date is known as the maturity date, in that case, you typically must pay a penalty.

And the penalty amount is typically calculated as an amount of interest depending on the term. So for example, a one year CD might charge the equivalent of three months worth of interest if you dip into it. So it’s crucial to be sure that you will not need to withdraw any amount of money before the maturity date when you’re buying a CD. So I mentioned that there are different types of CDs. There are some with a fixed term and interest rate, that’s called a traditional CD, and it’s the most common type. But depending on where you buy a CD, you may see some other types as well. So let me run through a few of these that you, you know, you may or may not see at the institution that you’re using. One is called variable CDs. These pay an interest rate based on an index, such as the treasury bill rate or the prime rate.

There are zero coupon CDs. These pay interest only at the end of the term, and they don’t allow the option to withdraw interest as you go. So if you had a five year CD, you would have to wait until the end of those five years to get any interest. There are add on CDs, which allow you to make additional deposits to either a fixed or a variable rate CD. There are callable CDs, these the bank, the right to call or buy back a CD after an initial period. And before the end of the terms, you would get your money back. There are liquid or no penalty, CDs. These allow you to withdraw a portion of your money without paying a penalty. So that’s a good option if you’re not really sure if you might need the money or not, of course, it’s going to come with a lower interest rate. In most cases, there are bump up CDs. These give you a fixed interest rate with the option to increase the rate. One time during the term of the CD to take advantage of any rising interest rates, there are step up or step down CDs. These give you a fixed interest rate for a set period, and then automatically increase or decrease to a predetermined rate. And lastly, jumbo CDs. These require a deposit of at least $100,000 and typically offer a higher rate of interest.

So speaking of high rates of interest, how do you find high yield CDs? You know, as I previously mentioned in general, the longer a CD term, the more interest you earn. So let me give you some examples from right now, you know, as of the recording of this [email protected], you can find that first internet bank of Indiana has a five year CD paying 1.7, 7% APY and ally bank has a one year CD that pays 1.3, 5% APY. So going from a one year CD up to a five year CD is gonna get you a little more money. If you put a hundred thousand dollars in this one year CD, and you did not withdraw any interest along the way at the end of the year, you would have $135 extra at the end of the term. Now, if you want to figure out returns on CDs with longer terms than one year, it gets a little bit more, more complicated, and Bankrate has a CD calculator.

That’s pretty handy. If you want to check it out, just like with high yield savings accounts, you can find the highest paying CDs at online banks, credit unions and investment firms. They typically have lower overhead, which means they get to pass the savings along to customers in the form of higher interest rates. But I will say that local community banks and credit unions can offer very competitive CD rates when they’re trying to attract more deposits. So, you know, you really need to shop around to find the best rate. Now let’s talk about something called CD laddering. This is a common strategy to maximize earnings by using multiple CDs, laddering, just like, you know, crawling up a ladder. You buy CDs with different maturity dates and annual yields. Each one represents a run on a CD, you know, quote unquote ladder that goes from shorter terms up to longer terms.

So imagine that you bought a hundred thousand dollars traditional five year CD paying one seven, 5%. Now think about how bummed out you’d be. If you put all that money into a five year CD, you locked it up. And then interest rates went up. They went up to 75%. So you’re missing out on a whole percentage point on your money. If that happened, let’s say the following year, you’d be missing out on earning more interest because you locked up your money at the lower rate at 1.7, 5% for five years, and he can’t make a withdrawal without paying a penalty with lattering. You might choose to buy five CDs with that a hundred thousand dollars. Instead of just one. For instance, you could buy a $20,000 one year CD, a $20,000 two year CD at $20,000, three year CD. And so on up to a five year CD after one year, when the very first CD reaches maturity, you could use all or a portion of the money to purchase another five year CD.

So as your shortest CD matures, you can use that money to buy a longer term CD that presumably has a higher interest rate. So this technique of laddering protects you against missing out on higher returns. If interest rates do rise, you’re going to get more money and get greater flexibility, same time as each seat, the matures you’ve got the option to renew it at the current rate or to use your money for something completely different. So you can use a CD ladder calculator to see how you might benefit from using this strategy and in the notes for the show. Again, they’re in the money girl [email protected]. I’ll put a link to a really good CD ladder calculator. All right. Now, should you buy a CD now that you know, a little bit more about CDs, let’s go back to Anna’s question about whether she should buy one.

I do not recommend putting any amount of your emergency fund and in a CD, why? Well, it’s going to cost you. If you need to make a withdrawal. Now say you’ve got more cash on hand, and then you need, if that’s the case, yeah, we’ve got plenty of money for your emergency fund. And you’ve got even an excess of cash. In that case, buying one or more CDs may make a lot of sense. First, you’ve got to set your target emergency fund amount in I’m going to recommend the equivalent of three or six months worth of your living expenses, but how much you need might depend on your work and your family situation. For instance, if you’re the only breadwinner and a very large family, you might to save 12 months of living expenses instead of three or six months. So if Anna has more than a healthy amount of savings for her situation, putting the excess in a short term CD might be, yeah, good option.

She could earmark it for something specific, such as a vacation or that house that she plans to buy and would happen after the CD maturity date. I recommend that Anna make accumulating a down payment, a separate goal from building and maintaining her emergency fund. So if you’re in a position with plenty of cash and you’re ready to buy a CD, you need to compare rates to high yield savings accounts and money market deposit accounts. To really understand what you’re going to gain from buying a CD. In some cases, you might find that the rates are very close or even lower than some savings products. In that case, you know, buying the CD doesn’t make sense. You’re going to want to stick to a high yield savings account. So you don’t sacrifice any liquidity. If you’re going to get the exact same return on a CD, and let’s say a money market deposit account, you don’t want to lock up your money.

You’d rather have it in the deposit account so that you can get to it 24 seven and use it if you need it. So remember, the point of having an emergency fund is to have the ability to tap it the moment that you need it. And that may not be the case of the money is in a CD balancing risk and reward is something that savers and investors must manage. I mean, it’s just something we’re always concerned about, especially when interest rates are at record lows. Like they are now, CDs do not offer much return on your money, but they do give you a guaranteed return. So to sum up, buy a CD, only when you have fully funded your emergency fund, and you still have a large amount of cash that you want to keep safe. You can use one or more CDs. If you can earn more interest on those CDs than you would with a savings or money market deposit account.

And this could be the situation for you. If you’re retired or you’re nearing retirement, or you’ve got a specific goal that you want to reach after a CD matures, such as buying a home, starting a business, or making any other large purchase. And I hope that gives you some direction. Thanks so much again for your voicemail. If you have a money question or an idea for a future show topic, you can call it in just like Anna did. I’d love to hear it. The number to leave your message is (302) 364-0308. Or you can email me. I’d love to get your email as well. You can do that by visiting my [email protected]. That’s all for now. I’ll talk to you next week until then here’s to living a richer life. Money girl is produced by the audio wizard, Steve Ricky Berg with editorial support from Karen Hertzberg. If you’ve been enjoying the podcast, take a moment to rate and review it on Apple podcasts or wherever you get your podcasts. You might also like the backlist episodes and show notes that are always [email protected].