Top 18 tips for CD savers

Opening a certificate of deposit (CD) takes a little more planning than opening other types of bank accounts, because CDs lock in your funds for a set time — be it months or years — and generally impose penalties for early withdrawals. But CDs can be a useful tool to help grow your savings and diversify your portfolio, especially in today’s environment. Some CDs – particularly short-term offerings in the 6-month to 2-year range – are paying rates near or above the 5 percent mark.

Here are 18 top tips to utilize CDs to build your savings.

1. Figure out why you’re saving the money

If the funds are likely to be used within the next few months, a savings account or money market account is a better option than a CD.

“The first thing that we do is think about when money might be used, or if it’s earmarked for a specific goal,” says Lauren Zangardi Haynes, certified financial planner and founder of Spark Financial Advisors.

One smart reason to choose a CD with a fixed rate is you’ll know exactly how much money you’ll earn during the term. So, if it’s June 1 and you’re trying to save for a vacation next summer, a 1-year CD can be a good place to park your money, let it grow and avoid the temptation of spending it.

But if you’re trying to grow your money more aggressively over a longer period, other types of investments may be a better fit. Stocks, mutual funds, exchange-traded funds (ETFs) and index funds may offer higher gains, though they also have the potential to lose principal.

2. Make sure you have enough liquid cash in your emergency fund

Consider a CD for funds that don’t need to be accessible in the short term.

Money meant for a near-term purchase or emergency savings should be in a liquid account, such as a savings or money market account. These accounts allow you to access your funds anytime, without penalty.

Longer-term CDs have historically paid higher rates, although that’s not always the case in today’s environment. Right now, as banks and credit unions wait for decisions from the Federal Reserve on interest rates, they aren’t willing to lock in the highest rates on longer term CDs.

3. Shop around

Getting a good deal requires research. See what your bank is offering, then compare that to what the average CD pays. Don’t accept the average, either. Right now, the average rate for a 12-month CD is just 1.81 percent – not high enough to keep up with inflation. Look for a bank that offers rates significantly higher than the national average.

Next, compare the best rates online for the terms you’re considering, because online-only banks typically pay higher rates than those offered by brick-and-mortar banks. Online banks don’t have the expenses related to maintaining branches, so they can generally pay better yields. They also need a way to attract your deposits, which they do through higher yields. Similarly, credit unions are sometimes able to pay higher rates because they’re not-for-profit organizations.

4. Be sure it’s insured

CDs are smart investments if you don’t want to risk your principal, but you need to make sure that you’re only comparing options at insured institutions. That way, if it fails, your money is protected. A CD opened at a bank insured by the Federal Deposit Insurance Corp. (FDIC), for example, provides safety to consumers. Each depositor at an FDIC bank is insured to at least $250,000 per insured bank, per ownership category, according to the FDIC.

Share certificate is the term used by credit unions for CDs. These are insured by the National Credit Union Administration (NCUA), which operates and manages the National Credit Union Share Insurance Fund. The standard share insurance amount is $250,000 per share owner, per insured credit union, for each account ownership category.

5. Compare rates over time

Historical CD rate trends matter when you’re determining how valuable a CD will be for you in the future.

If rates are historically high and predicted to drop (which may happen later this year if the Fed makes its long-anticipated rate cut), it could be an opportune time to lock in a longer-term rate, guaranteeing earnings during market volatility. On the other hand, when rates are low and might increase in the near future, it might be better to stick to shorter-term CDs or invest in a higher-yielding type of account.

6. Start your search at online banks

Online banks are good places to find the highest APYs. A traditional brick-and-mortar bank may be a better fit if you prefer meeting with a banker, but the APY likely will be lower.

Online banks tend to offer higher yields and lower fees, generally because they have less overhead, compared with brick-and-mortar banks, and can pass on that savings to customers.

7. Look at smaller institutions for promotions or bonus rates

Don’t limit your search to the internet, though. Local banks and credit unions may offer bonuses and special rates typically reserved for larger deposits. Community banks may offer CDs with attractive rates to consumers in specific cities or counties. Some smaller institutions also offer more flexible CDs such as add-on CDs that allow you to make additional deposits throughout the term.

When considering a CD with a promotional rate, take a look at the institution’s standard rates, which can provide an idea of whether CD rates will be competitive when they are up for renewal.

8. Avoid automatic rollovers

When a CD’s term ends, a grace period will be offered of around seven to 10 days, during which you can choose to withdraw the money without penalty.

On the other hand, if you do nothing when the term is up, the bank often renews the CD automatically for a term of the same length. This is known as an automatic rollover, and the new CD will earn whatever annual percentage yield (APY) the bank is currently offering for that term.

Set a reminder on your calendar to reevaluate your CD as it’s set to mature — especially if you had a promotional rate — or it may renew at an unfavorable APY. A CD that was competitive when first opened might be less so at renewal time.

9. Know when you’ll need the money

Determining when you’ll need your money can help you avoid early withdrawal fees. CD terms typically range from three months to five years.

A one-year CD may be a good investment if you’re planning to buy a house sooner rather than later. You’ll be protecting principal and also earning a competitive yield.

“We don’t necessarily want to take on a lot of risk by investing it, but we’d like to earn a little more interest,” says Spark Financial Advisors’ Zangardi Haynes.

Money you won’t need for at least five years could earn a higher return in other investments, such as stocks, mutual funds or ETFs, but those strategies offer no guaranteed return.

10. Look at minimum deposit requirements

Some banks require a minimum deposit of $1,000 to open a CD, while others may offer competitive rates with a lower minimum amount, so it pays to shop around. Look elsewhere if you feel the minimum to open an account is too steep.

Various banks require no minimum deposit for their CDs, so you can choose to deposit any amount you’re comfortable with. Just keep in mind that though there may be no minimum deposit requirement, you may need to meet a certain minimum to earn the highest rate.

11. Avoid fees

Fees can result in considerable loss of your earnings on a CD, so it pays to know what the rules are for early withdrawals. You could end up walking away with less money than you started with if you have to end the agreement early.

A penalty of 90 days’ worth of simple interest is a common early withdrawal fee for a one-year CD, though some banks have penalties of six months’ worth of simple interest or more. Other banks may have even steeper penalties or may penalize based on a percentage of the withdrawal. Some banks, for example, impose a penalty of 540 days of interest on funds withdrawn prematurely from five-year CDs.

12. Go short-term when it makes sense

An APY that’s a few basis points higher may not be worth it if the term is longer than you’re willing to consider. If your time horizon is on the shorter end, a savings account that pays a comparable APY to short-term CDs could be an alternative. Keep in mind, however, that rates on savings accounts are variable while those for CDs are fixed for their terms.

Choosing a savings account with a variable rate may be preferable to opening a fixed-rate CD at a time when deposit account rates are rising, for instance. The opposite can be true during a falling-rate environment.

13. Ladder your CDs

A CD ladder is a strategy using multiple CDs maturing at different intervals to take advantage of higher interest rates. It’s best used when interest rates are rising or when there is little difference between short- and long-term rates. A CD ladder can help you lock in high APYs if rates continue to decrease. In a decreasing-rate environment, longer-term CDs might be earning a favorable APY that is no longer offered.

Opening a one-year, two-year and three-year CD at the same time is an example of laddering, allowing you to more easily avoid early withdrawal penalties and diversify your portfolio.

14. Consider a barbell strategy

A barbell strategy is similar to a ladder, but with the middle rungs missing. Short maturities make up one end of the barbell, or investors may even put money in a high-yield savings account to keep part of the principal more liquid. Long-term maturities make up the other end of the barbell.

If you’re looking at a longer-term CD, weigh the potential increase in APY with the potential early withdrawal penalty, says Amy Hubble, certified financial planner at Radix Financial.

“You can usually get the most value by going ahead and doing the longest-term CD that they offer, which is usually five years,” Hubble says. But you’ll also need to consider whether longer-term CDs are a good value if shorter-term CDs have similar yields.

15. Consider indexed CDs

An indexed CD, also known as a structured CD, is a nontraditional certificate of deposit that is linked to other investments, such as stocks, bonds, currencies or commodities. Though indexed CDs likely won’t lose money as long as they are held to maturity, returns are typically capped at a percentage of the total return of the underlying index or basket of securities.

For example, if it’s linked to the S&P 500 and that index gains 10 percent over the year, a structured CD may yield three-quarters of that return. Structured CDs vary and can be more complex compared with a conventional CD. But the potential for greater returns appeals to some savers with intermediate time horizons, typically of two to four years. Additionally, these CDs aren’t nearly as commonly offered, so you’ll need to do some extra shopping to find them.

16. Evaluate step-rate CDs

A step-up CD is an investment option that comes with pre-determined rate increases during a CD’s term. Step-up CDs differ from bump-up CDs, which only permit an increase in the yield when rates actually increase (very unlikely right now, which makes bump-up CDs a less attractive option).

But step-up CDs generally feature APYs that are set to increase to predetermined amounts on scheduled dates. To get the best rate, compare the blended APY to see what it averages out to during the term.

Also, some banks use the terms step-up CD and bump-up CD interchangeably, which can cause confusion. Read the fine print to figure out whether the bank has a plan to automatically increase your rate or if you have to request one.

17. Look into brokered CDs

Brokered CDs are purchased through a brokerage firm and are an option for those looking for higher rates than those offered at banks on regular CDs. Brokered CDs also allow investors with more than $250,000 to insure all of their funds with the FDIC by offering CDs issued by multiple banks. Just make sure you know what bank a brokered CD is at so you don’t exceed FDIC limits with other accounts you may have at the bank.

Terminating a brokered CD early is more complicated than with a traditional CD because you may have to sell your ownership interest, via your broker, at the current market value. Depending on the rate environment, terminating your investment early could cause you to lose some of your principal.

Brokered CDs are a riskier option than bank CDs, according to the Securities and Exchange Commission, because you may lose some principal or have to sell for a loss if rates increase after you open a brokered CD.

The Financial Industry Regulatory Authority recommends confirming you’re listed as the owner of the CD at the bank or that the CD is held in your name by a trustee or custodian, to ensure you receive FDIC coverage.

18. Check out no-penalty CDs

With a regular CD, you’ll usually incur a penalty for making an early withdrawal before its term is up. But a no-penalty CD allows you to make a penalty-free withdrawal, generally after the first week of opening or funding the CD. The trade-off is you could earn a higher yield with a regular CD.

Bottom line

CDs may be a good choice for savers who prefer a guaranteed rate of return and who are able to lock in their funds for a set period of time. When opening a CD, it’s important to only invest money you won’t need access to before the term expires. Otherwise, you may be hit with a hefty withdrawal penalty.

In addition to shopping around for the best CD rates, it’s important to choose a CD term that fits in with your financial goals. Depending on your circumstances, it may be wise to consider a no-penalty CD, a step-up CD, brokered CDs or IRA CDs. Other available CD strategies include CD laddering and creating a CD barbell to reap the benefits of multiple CDs that mature at different times.

When used with the right strategies, CDs can be a component of your financial portfolio that provides stability and security.

— Bankrate freelance writer David McMillin contributed to updating this article.