Most people think having a savings plan is putting money aside for an emergency or a rainy day. Having an effective savings strategy is more complicated than that. You should use different saving vehicles to protect your money and earn maximum returns, including certificates of deposit (CDs). It pays to have a diversified savings plan.
Creating a diversified savings strategy starts with how you think about savings. There are different types of savings tools based on your savings goals. Retirement planning is a unique savings strategy where you want to maximize returns over years or decades.
CDs can be a valuable part of your savings strategy once you understand how they work and what to expect.
What Are Certificates of Deposit?
A certificate of deposit is defined as a savings account that holds your money for a fixed period of time, from a few months to a few years. When the CD matures (i.e., at the end of the deposit period), you get your original investment back plus interest. If you choose to redeem your CD before it matures, you must pay a penalty from the interest earned for early withdrawal.
CDs differ from savings accounts in several ways:
- The money isn’t liquid, so you need to leave it on deposit for the life of the CD.
- Typically, the longer you keep the money on deposit, the higher the interest rate.
- CDs are secure and federally insured up to $250,000.
- CDs can be a hedge against inflation since they have fixed interest rates.
You can choose CDs with deposit periods that range from three months to five years. iQ Credit Union offers CDs from 3-60 months, paying higher interest rates the longer you invest. We also have regular CD specials with higher rates. Note that some financial institutions require a minimum deposit of $500 or more for a CD; iQ doesn’t.
Including CDs in a Diversified Savings Plan
CDs can fit into a diversified savings strategy in various ways. CDs are a great way to protect your savings for future spending needs. For example, if you plan to buy a car in the coming months, a CD is an excellent way to save a down payment with a maximum return on your savings.
Think about putting your savings in a CD if you want to set your money aside and get a guaranteed maximum return without risk. With stocks and mutual funds, you run the risk of losing money you invested, and your investment is not secured. CDs are secured by the government, so you know your money is safe, plus you get a guaranteed return.
Your diversified savings plan should include a savings or money market account as an interest-bearing account where you can put away extra cash. As your savings account grows, you can transfer the surplus into a CD, where your money earns more interest.
If you want to include CDs as part of your retirement savings strategy, consider an IRA CD. An IRA CD works like an individual retirement account (IRA), but you lock in the interest rate in a CD. This has some tax advantages and ensures you get a fixed rate of return on your retirement savings.
CD Types and Terminology
The various types of available CDs can be confusing. To help you find the best one to include in your savings strategy, here is a breakdown of some of the most common types:
With a traditional CD, you make a one-time deposit that meets the financial institution’s minimum deposit requirement. The interest rate is fixed, and the money stays on deposit until it matures. You can then cash out the CD, receiving your original investment plus interest, or roll the amount over for another term. There are stiff penalties for early withdrawal.
A bump-up CD lets you take advantage of rising interest rates. A bump-up CD has a fixed interest rate but lets you increase the CD's annual percentage yield (APY) if interest rates improve. Most bump-up CDs have lower rates than other CDs and only allow one bump-up per term.
A liquid CD has no penalty for early withdrawal. The interest rate for a liquid CD may be higher than a savings or money market account but will likely be lower than a traditional CD.
Financial institutions will offer special deals on CDs at more attractive or high-yield interest rates to be more competitive.
As the name implies, a jumbo CD requires a larger deposit, sometimes as much as $100,000. The return on a jumbo CD may or may not be better than a traditional CD, depending on the bank or credit union.
Choosing the Best Certificate of Deposit
You should look for specific features when shopping for a CD, starting with the annual percentage yield (APY). You want the best rate of return, and the APY will tell you what you will earn when the CD matures. You also need to consider how long you want to keep your cash on deposit, which will affect the APY.
Also, be sure you understand the penalties for early withdrawal. Most CDs have stiff penalties on the interest earned for early withdrawal. You should know what it will cost if you need to cash in a CD to cover a financial emergency. You should also ask how frequently the CD earns interest: monthly, quarterly, or annually. That will tell you how fast your money will grow if you need to liquidate the CD early.
If putting your money in CDs is appealing, consider laddering. Laddering lets you earn more while maintaining some liquidity by splitting your CD investment. For example, you can invest in three-, two-, and one-year CDs. After the one-year and two-year CDs mature, you can cash them out or roll them into the three-year CD to get a higher interest rate.
Certificates of deposit should be part of any diversified savings strategy. The professionals at iQ can explain the various CD options available and assist you in finding the best CD to help meet your savings goals.
Check out The Ultimate Guide to Simple Savings to learn more about CDs and other ways to save.