The benefit is often not worth it to me.
- Certificates of deposit tend to pay higher interest rates than savings accounts.
- They also come with restrictions that make them less appealing.
I firmly believe in having a lot of money in the bank. First, everyone needs savings in case of a financial emergency, like a layoff or home repairs. And also, when we save for short-term goals, investing our money can be a dangerous thing, especially because we risk losses. So it’s a good idea to keep the money you might need in the bank for the next few years.
But in banking, you have a choice. You can put your money in a regular savings account. Or you can open a certificate of deposit (CD).
The advantage of CDs is that they tend to pay higher interest rates than traditional savings accounts. But despite this advantage, I’m really not a big fan of CDs.
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Not much advantage
If your goal is to get the highest possible interest rate on your money, a CD may be a good choice for you. But it’s also important to recognize that CDs have drawbacks.
For one, with a CD, you are required to lock in your money for a predetermined period of time. It can take six months, a year or more. If you cash in your CD early, you risk a penalty of several months of interest.
Also, while CDs generally pay higher interest rates than savings accounts, sometimes their rates are not this much higher. And so you don’t get a lot of financial benefit in exchange for having to commit to keeping your money where it is.
But perhaps my biggest complaint with CDs is that their prices can change from month to month. And so if you put money into a longer-term CD, you could end up wasting a lot of time being locked into a lower rate.
Let’s say you commit to a one-year CD paying 2% interest, then three weeks later you see that same CD term advertised at 2.4% interest. Suddenly you lost interest due to bad timing alone.
Should I open a CD?
CDs give you the opportunity to earn more interest on your money while it’s parked in the bank. If you’re saving for something like a down payment on a house and you know you won’t need the money for a few years, you might want to put it on a short-term CD.
But be careful with longer term CDs. Not only do you risk locking yourself into a lower interest rate, but you also risk being penalized if you need that money in a heartbeat.
In fact, while a savings account is a great place for your emergency fund, you might not want to use a CD for this purpose. Certainly, your principal deposit will be protected and you can always decide to make peace with a penalty of a few months of interest if things go wrong. But I try to limit the extent to which I use CDs. And given the limited benefit, you might want to take a similar approach.
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