Unsure About Committing to a CD? 5 Ways to Make It Work

Certificates of deposit (CDs) are a way to earn more interest on your savings, but the main trade-off is that they require you to keep your funds deposited for a set amount of time, generally measured in months or years. Some savers get skittish at the idea of committing to a CD without knowing when they'll want or need the funds, in addition to being worried about the price they'll pay if they find they can't stick it out.

Fortunately, there are several strategies you can take to lessen the commitment risk and potential penalty hit of a certificate of deposit. That may make you more comfortable with taking the gamble and, in turn, let you reap the rewards of a higher return on your savings.

Key Takeaways

CDs can be a smart way to boost what you earn on your bank savings, but they require you to commit your funds for set period of time or pay a penalty if you cash out early.
One smart strategy is to check if your timing is good relative to where it's expected the Federal Reserve will take rates in the near future.
It's wise to put only a portion of your savings in a CD while socking away another portion in a high-yield savings or money market account that offers penalty-free access.
Maximize your earnings and minimize your penalty risk by doing your homework to score a top-rate CD from an institution with a mild penalty policy.
Consider divvying up your CD investment into several smaller CDs; this way, if you do need some of your funds early, you can cash out one or two CDs and keep the others until maturity.

Strategy 1: Check If Your Timing Is Good

Though CDs can be a smart move at any time, various CD terms can make more or less sense at different times given the general U.S. rate environment. That's because the rate on a CD is fixed, meaning it does not change for the full duration of the term period.

So if, for instance, rates are expected to rise in the future, it's not ideal to lock in a long-term certificate at today's lower rates. A short-term (3 to 12 months) or mid-term (18 months to 3 years) CD would be better in this situation, so you can exit sooner and capitalize on a better rate in the future. On the flip side, if interest rates are expected to fall, a long-term certificate (4 years or more) is an excellent choice, as it will give the CD more time to accrue interest at today's higher rates.

Though it's impossible to fully predict exactly where interest rates will go, their general direction over the coming year is not as tough to decipher. What banks and credit unions pay on CDs and other deposit accounts is directly influenced by the Federal Reserve and what it is doing with the federal funds rate. So some simple internet searching on current Fed news can give you a reasonable indication of whether to expect a falling, rising, or stable rate environment in the next year.

While it can be tempting to just keep all of your savings in a high-yield savings account (on the assumption that it pays almost as much as a CD but with less commitment), beware that savings and money market account rates are variable. The bank or credit union can change them at any time and without notice. So while you may be able to earn a high yield on a savings account right now, that rate could go down, while a CD's rate is guaranteed for the full term.

Strategy 2: Only Put a Portion of Your Savings in a CD

One way to lower the chance of needing to exit a CD early is to not put too much into it. Simply decide what portion of your savings you're fairly confident you can live without—for whatever term length you're considering—and leave the rest of your funds in a savings or money market account. That way you'll have ample funds that are easily accessible, should you need them.

A key point in this strategy is not to put your non-CD savings in just any account; rather, you should seek out a top-paying high-yield savings or money market account. By opening an account with a nation-leading rate, you can still earn a very competitive return on your money, while retaining the ability to deposit and withdraw funds when you like.

For added safety, you can also keep a small cash reserve in a traditional savings account at the same financial institution where you have a checking account. This way, you can make an instantaneous transfer to your checking anytime you need to.

You can find the top nationwide rates in our daily rankings of the best high-yield savings accounts and best money market accounts. All are offered by FDIC-insured banks or NCUA-insured credit unions, keeping your deposits safe even if the institution fails.

Strategy 3: Think Ahead When Choosing Your CD Term

Selecting the right CD term is also important. Given the rate environment, you may want to pick as lengthy a term as you feel you can manage, thereby maximizing the rate you can secure. But it's also smart to avoid overextending your commitment. Think ahead about what's on your personal financial horizon: Will you be buying a house or car? Will you need to start paying a child's college tuition? Do you have a big vacation planned?

You'll never be able to predict surprise and emergency expenses you'll encounter. But it's worth spending a little time thinking ahead about the money needs you can expect to help you choose a CD maturity date that fits into your financial timeline.

Strategy 4: Do Your Homework on Rates and Penalties

Whatever deposit amount and CD term you land on, you will always be well served by shopping around for a nation-leading rate. The yields that different banks and credit unions pay can vary by an astonishing amount. You can see this in the chart below, which shows the current top rates in every CD term vs. the national average rate. In most cases, you can earn three to five times the national average by doing your homework to choose a leading rate.

Seeking out a high-yield CD is about more than just the rate, though. It's also about your resulting return should you need to cash out of the CD early. There will always be a penalty if you don't make it to maturity, so the higher the earnings on your CD, the less damage your penalty will do to your overall return.

For instance, let's say you open a CD paying 3%, but a financial emergency causes you to cash out early. If the resulting penalty eats a third of your earnings, that's equivalent to still earning 2% on that CD, even after paying the penalty. Compare that to a CD paying a dramatically lower rate, like the national average, and you can still come out ahead on the penalized high-rate CD.

The second step is to make sure you know the early withdrawal penalty of any CD you're considering before you commit. Some penalties are fairly mild, some are middle-of-the-road, and some are frankly so harsh they should be avoided. These include any penalty policies that can reduce the principal of your initial deposit.

Instead, you'll want to choose a CD with a mild or reasonable penalty calculation. Typically, these take the form of a number of months of interest that you'll forfeit. By investigating the early withdrawal penalties on a short list of CD options you're looking at, you can choose one that, for instance, charges three months of interest instead of six months.

We make the research easy for you, by tracking rates every weekday and publishing our ranking of the best CD rates for terms from three months to 10 years. All CDs in our list are offered by federally insured banks and credit unions, meaning you are protected in the unlikely chance that the institution fails.

Strategy 5: Consider Multiple Smaller CDs

Yet another strategy is not to deposit all of the money you've earmarked for CD investment into a single certificate. There are two different ways to diversify here to minimize your risks.

One path is to split up your CD deposit into four or five smaller amounts. Say you want to invest $20,000 in a CD. Instead of a single CD at that amount, you could open four CDs of $5,000 each at that same institution. What you gain here is that if you find you need to access some of your CD funds before maturity, you won't necessarily have to cash in the full $20,000. Instead you could just break one or two CDs to get the cash you need, and then you would keep the remaining CDs intact (at least until they mature).

Another option is to invest in more than one CD, but not all at once and perhaps not all at one institution. Using the same $20,000 example as above, you could invest $5,000 now, but then plan to invest another $5,000 every month or every quarter. This is a good strategy if you're unsure where rates are going, and it works out well if rates rise. It also staggers your investments and therefore your maturity dates. However, if rates fall, you may wish you had invested all of your funds at once back when rates were higher.

Savings Account vs. CD - Which Is Better?

Savings accounts have the advantage of allowing you free access to withdraw or deposit your money more or less when you like. But their interest rates are usually lower than CD rates, and the rate can be changed at any time, without notice.

CDs instead offer a guaranteed fixed rate, so not only can you usually earn more with a CD, but there is no risk of the rate being reduced. You’ll know exactly how much you’ll earn until the end of the CD term. The trade-off, however, is that if you cash out before the maturity date, you’ll incur an early withdrawal penalty.

Deciding between these two depends on when you’ll need access to your money. If you know you won’t need some of it for months or years, then a CD can boost your earnings. But if you’re unsure when you’ll want to withdraw the funds, a savings account offers better flexibility. For many people, CDs can be a good option in combination with keeping some money in a high-yield savings account.

Should I Put Money in a CD Right Now?

Whether now is a good time to open a CD depends both on your personal financial situation and on the general interest rate environment. First, putting money in a CD makes sense if you know you can live without a portion of your savings for some number of months or years. It can also help you save money without the temptation to spend, since cashing in a CD will cost you a penalty.

Second, it’s good to have some idea of where U.S. interest rates are generally headed over the coming year or so. If it’s widely expected that interest rates will fall, then opening a long-term CD is a smart move because it allows you to lock down one of today’s better rates. But if it’s expected interest rates will soon rise, shorter-term CDs are likely a smarter bet.

Can I Lose Money on a CD?

Virtually never. What you put into a CD is yours, and assuming you open it at an FDIC-member bank or an NCUA-insured credit union, up to $250,000 of your deposits—per person and per institution—is federally protected if the institution fails.

The only way you can lose money on your initial CD investment is if you choose to open it at a bank or credit union that has such a harsh early withdrawal penalty that it can subtract from your principal deposit. Most penalty policies only reduce your interest earnings, but if you encounter one that can eat up more than interest and reduce what you originally deposited, shop elsewhere for a different CD.

Are CDs Safe if the Market Crashes?

What the stock market does will have zero effect on any CD you already hold. That’s because CDs offer a fixed rate that the bank cannot change during your CD term. What you sign up for at the outset is what you are guaranteed until the CD matures.

It’s true that changes in the U.S. economy or stock market can impact the rates of future CDs. But you will always know the rate and duration of a new CD before you sign on the bottom line, and once you do, that agreement between you and the bank or credit union is then locked in, no matter what happens in the economy or the stock market.

The Bottom Line

It's wise to take a CD investment seriously, since the way to maximize the earnings advantage it offers is to hold the CD until maturity. But by following these strategies, you can significantly reduce the chances of needing to cash out early. And then even if you do, you'll have minimized the costs of the penalty as much as possible.