When you first start saving money consistently, you probably just transfer the funds into a savings account linked to your checking account. But as that amount grows, it’s time to start thinking about a more robust savings strategy.

certificate of deposit

A traditional savings account provides the least amount of interest possible. While there are certainly advantages to keeping some money in that type of account, you may not want it to be your only option. One great choice for diversifying your savings is called a certificate of deposit. Also known as a CD, this type of savings account typically offers higher interest rates in exchange for a fixed length of deposit.

There are a number of unique features that differentiate a CD from your normal savings account. Find out everything you need to know about it to determine how it fits into your savings plan. You’ll learn more about common rates and terms, different types of CDs you can get, and whether or not it’s right for you. A CD can be a strong tool to have in your savings arsenal as long as you know the details involved.

What is a CD?

A certificate of deposit is similar to a traditional savings account in that you deposit your funds into a bank account. But that’s where the similarities end. The biggest difference is that a CD involves a timed deposit. That means instead of withdrawing money as often as you wish (like you would with a normal savings account), you must instead keep it there for a predetermined length of time.

The term length varies depending on which account you choose. Generally speaking, you can expect to earn a higher interest rate the longer you agree to leave your money in the CD. You may also qualify for a higher interest rate, or annual percentage yield (APY) if you deposit a larger amount of cash. So if it’s not money you need immediate access to, a certificate of deposit can be a more lucrative way to make your savings work for you.

You can get a certificate of deposit at just about any financial institution. When looking at a credit union, they might be referred to as share certificates. In addition to brick and mortar banks near you, you can also look at online banks to determine the best APY. It’s also good to shop around to find the best rate for the term length you’re looking for. The end of a CD term is referred to as its “maturity,” so keep an eye out for that number when comparing CD accounts.

It’s also worth checking banks for a bonus CD rate. You may find a good deal at a bank where you hold existing accounts or could take advantage of a new customer bonus at a new financial institution. The bottom line is that when considering any type of financial product, you should always do your homework before making a decision.

What are the features of a certificate of deposit?

When researching different certificates of deposit, there are a few different characteristics you should look out for. The first two, which are commonly linked together, are the APY and the term length. Depending on the bank and the term length, you can expect to find CD rates ranging anywhere between 0.03% and 1.25%, with the average rate at about 0.5%.

Term lengths can range anywhere between one month and ten years, so you have a wide range of options to choose from. There’s also likely a minimum deposit amount. Most banks require at least $1,000 but you may be able to shop around for a lower minimum if you need to. There may also be a maximum, with many accounts capping deposits at $10,000. You can always spread out extra cash across multiple accounts, especially if you want to vary the term lengths.

Since CDs have a term length, you’ll incur a penalty for withdrawing funds early. The amount is stated in the terms and conditions of your account, usually ranging between three and six months of accrued interest. It’s in your best interest to avoid early withdrawals, so you don’t have to pay this penalty. That’s why it’s wise to diversify your types of savings accounts so that you have sufficient funds in more liquid accounts to cover a financial emergency.

For a little more flexibility, you can search for a bank that offers one free withdrawal throughout the term. It’s also smart to make sure you CD is insured. Most banks insure customers’ money through the FDIC for up to $250,000 per account. Credit unions offer the same protection through the National Credit Union Administration. Deposit insurance is typical with most financial institutions, but it’s smart to check.

What types of CDs are available?

While most certificates of deposit have the same characteristics, you can find different types to fit your specific needs. Here’s a brief description of some of the most common types of CDs available today. Browse each one to find the best one for your finances.

Variable Rate CD

A typical CD offers a fixed rate of interest, meaning that your money earns the same amount over time. With a variable rate CD, however, your APY changes based on a broader interest rate. Different banks will use different drivers, such as Treasury bills or the prime interest rate.

Your rate would then be whatever the current base rate is plus a certain amount. If that market rate goes up, you benefit from a higher APY. If it goes down, however, you’ll earn a smaller amount than what you started run. It’s a bit riskier than a fixed rate, but may result in higher returns.

Step Rate CD

For a little more flexibility, consider a step rate CD. Your account gets to benefit from periodic increases in your interest rate, but you’ll probably be required to start with a higher minimum balance. You may also have the option to withdraw a portion of your funds at the time of each increase without having to pay a penalty fee.

Depending on the account you choose, you might be able to withdraw the entire amount, while other account types may require you to maintain your original minimum opening balance. The amount of flexibility you need can help you decide on the step rate CD that’s best for you.

Penalty-Free CD

A low-penalty or no-penalty CD gives you the most flexibility but does usually come with restrictions. For example, you might have fewer choices as to the length of the term. Additionally, you’ll probably need a higher deposit amount or be an existing customer at the financial institution. You’ll likely have a lower rate, but you do get the peace of mind that comes with having more liquid funds.

Callable CD

This is a unique certificate of deposit that offers a higher interest rate but gives the bank the prerogative to end the term at a time of their choosing. So if your CD is no longer financially beneficial for the bank, it becomes “callable.” Yes, you get the higher interest rate but you also run the risk of having to find another account for your money earlier than expected. Check the terms and conditions of this CD type to see exactly what it entails.

Market-linked CD

This is a much more sophisticated type of CD and is really a type of variable rate CD. Rather than using a specific base rate like the prime rate, your APY is instead linked to a specific market index. It’s a riskier type of CD because markets are more difficult to predict than standard interest rates. If you’re financially savvy, it’s worth looking into, just make sure you read all of the fine print that comes with your market-linked CD.

What is laddering?

Laddering your certificates of deposit is an investment strategy that essentially spreads your money out across several accounts and staggers their maturity dates. The idea is to eventually have one account maturing each year. At that time, you can choose what is best to do with it based on your current financial needs. If you need a cash infusion, you can choose to withdraw the funds. If you want to keep the money in a CD, you have two options.

The first is to do nothing. That’s because if you don’t touch a CD when it matures, it automatically renews using the previous terms and conditions. If your previous interest rate is higher than the current rate, then you can let the CD renew itself. Otherwise, your other option is to transfer it into another account that offers better terms. Laddering your accounts maximizes your financial flexibility over time.

Let’s take a look at an example of one way to ladder your certificates of deposit. Using an amount of money that meets the deposit minimums while still leaving you liquid savings elsewhere, you would first stagger your money over several different accounts. One way is to pick five accounts with term lengths ending in one, two, three, four, and five years.

As each account matures, you switch it to a five-year account, since that should (in theory) offer a higher interest rate than the lesser term lengths. Once your fifth account reaches maturity, you’ll then be on schedule to have one five-year account maturing each year. You can then decide whether to renew it or choose another account with a better rate. It’s also a great way to create more liquidity because you have the chance to withdraw every year without incurring a penalty fee.

Is a certificate of deposit right for you?

There are a few different things to consider when thinking about a CD account. First, make sure you have plenty of other savings available that you can access quickly, easily, and without financial penalty. Most financial experts recommend having $500 for an emergency fund, plus a few months’ of expenses to cover yourself during any type of job loss.

After you have that covered, think about your mid-term savings goals. What are you saving up for and when do you expect to need the money? Maybe you’re on a three-year plan to buy a house and have some cash saved up towards your down payment. If you’re sure you won’t need that money early, then a CD could be a good place to put it for a few years. If you have money set aside for long-term savings goals, you could also consider the laddering strategy to maximize your liquidity.

Another factor to consider with CDs today is how competitive the interest rates are. With most accounts offering an APY under 1.0%, they’re really not much more competitive than a traditional savings account right now. This is especially true considering the restrictions that come along with a CD. Prior to the recession and historically low interest rates for both saving and borrowing, CDs offered rates that were much higher than the typical savings account.

Now, however, there isn’t much difference in the yield you’ll receive from most accounts. However, interest rates are on the rise, which means CDs could be more competitive in the near term. It’s best to shop around for accounts of all types to make sure you’re getting the biggest bang for your buck. Then, do it again every six months to a year so that you’re evaluating your savings allocations on a regular basis.