What Is a CD and Should You Open One?

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Certificates of Deposit
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If you’re looking for a safe place to keep money that you don’t intend to spend soon, you may want to consider a Certificate of Deposit (CD).

What You Need to Know About CDs

Money expert Clark Howard says that CDs can offer higher interest rates than simple savings accounts and they don’t expose you to the risks associated with the stock market.

In this article, we’ll explain what CDs are. We’ll also cover when Clark says it might make sense for you to get one.

What Is a Certificate of Deposit (CD)?

CDs are contractual agreements you enter into with a bank. You give them access to your money for an agreed-upon term — typically anywhere from one month to five years. In return, you’re usually able to earn a higher rate of interest than you’d get in a simple savings account. Like savings accounts, CDs are insured by the FDIC.

Generally, the longer the CD term you select, the higher the interest rate will be. Depending on economic conditions, however, this might not always be the case.

How Are CDs Different Than Savings Accounts?

The biggest difference between CDs and savings accounts is the period of time you agree to have the money locked up. If you open a one-year CD, for example, and need to access your money before that 365 days is up, you’ll typically pay a penalty for withdrawing your money early. In most cases, that penalty will be forfeiting a certain amount of interest (most commonly 90 days worth) on your investment.

Simple savings accounts, on the other hand, are open-ended. The bank holds your money for you, but you can withdraw it at any time without penalty.

“You’re stuck in CDs at whatever rate you lock in for one to five years, and to get access to your money, you have to pay a penalty,” Clark says. “With savings accounts, the interest rate is only guaranteed for a single day. It can change whenever the institution wants to change the rate. But you also have access to your money at any time.”

In many cases, CDs will also require a higher minimum investment than savings accounts, which often have no minimum amount you can keep in them.

When Should I Consider Getting a CD?

Clark says that CDs have traditionally appealed to people who are on fixed incomes or are afraid of stocks and looking for more money on their savings. But he also says that there are some times when they make more sense than others.

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This means looking at the rates for both CDs and savings accounts and the amount of time you’re willing to have your money tied up.

“Generally, I prefer that people have money in savings accounts rather than a CD,” Clark says. “The only exception to that rule is when CDs are earning substantially more interest than a savings account or when interest rates are falling and it looks like they’re going to continue to fall. In that case, money that you don’t need immediately is best placed in a CD.”

Clark’s basic rule of thumb is that he wouldn’t invest in a one-year CD unless the rate was 1/3 of a percentage point higher than what you can get in an online savings account. For a two-year CD, he needs it to be 3/4 of a point higher, and for a five-year CD, 1.5 points higher than the savings rate.

What About No-Penalty CDs?

There’s a specific type of CD called a no-penalty CD that doesn’t play by all of the rules of traditional CDs.

“Occasionally, there will be CD offers where the penalty for canceling your CD before the full term is up is waived,” Clark says. “That can be a way to have your cake and eat it too.”

So, should you consider getting one of those?

“Only if the interest rate on the CD is competitive with what others are offering at the time,” he says.

How Do I Find the Best CD Rates?

Generally, you’ll find the highest interest rates on CDs at online banks. Some online banks that are known for having great rates on CDs are:

Read more about Team Clark’s favorite online banks here.

Most credit unions also offer something called “share certificates” that are similar to CDs. Check with your credit union and you may find rates comparable to — or even higher than — the online banks.

Final Thought

CDs are savings tools that are appealing in certain situations. However, it’s important to understand when they make sense for you and when they don’t.

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They’re a safe way to store your savings, but they don’t have the potential upside you see investing in the stock market. You know exactly what you’re getting in return for your money, for better or worse.

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