Who isn’t saving up for something big… either near or far out in the future? Whether that includes saving up for a down payment on a house, tuition to go back to school, or a big vacation you have your heart set on (or all of those things, and more), you have several options available to you to help grow your money. Some being more advantageous than others…
Most people tend to jump into a simple savings account (or even a high-yield savings account) to keep their funds in a safe haven while they prepare for that purchase. Or, if there is a high risk tolerance, investing in the stock market to potentially grow your funds is also an option. However, to keep your savings focused and on the right track, you should also consider CDs as a low-risk, high-return tool to grow your money.
Before diving into the benefits of CDs, let’s first do a quick refresher on what we’re talking about (and no, it’s not referring to selling old compact discs you may have still lying around the house). A CD stands for a ‘Certificate of Deposit’ and is similar to a savings account, but has a defined interest rate and end date. In other words, you deposit a lump sum of money for a fixed period of time with a financial institution, and that financial institution will pay you interest at a fixed rate during that time period. The keyword here is ‘fixed period’ – whether you choose three months or five years, during the time period that the financial institution agrees to hold your funds, you will earn interest at that fixed rate (the longer the time period being held, the higher the interest rate you’ll receive). Easy, right?
Here are some of the key benefits to investing in CDs:
- You get a higher rate of return than other savings accounts – who doesn’t want to maximize their return on investment? CDs offer higher interest rates than other saving accounts, including a basic checking or savings accounts, money-market accounts or money-market funds.
For comparison sake, let us break it down: the best nationally available savings account pays 1.6% APY. On the other hand, the best nationally available one-year CD pays 2.1% APY. To take it one step further, the best nationally available three-year CD pays 2.4% APY. (1) At ISUCU, you can take advantage of a two-year 2.40% APY* CD Special available through the end of August. Click here to learn more.
- You have a fixed interest rate locked in – there’s something to be said when you have a locked-in interest rate ready to be paid out at a specific date in the future. With the current market volatility, that cannot be said for all other savings options. Even with a simple savings account, a financial institutions can change its interest rate at any time. With a CD, you’re locked in – so even if interest rates drop, you’re still getting the same rate you are locked into.
- Little to no risk – the National Credit Union Association (NCUA) insures CDs up to $250,000 so rest assured, the federal government guarantees you will at least never lose your principal if the financial institution gets into trouble. Therefore, this option is clearly less risky than other investments, such as stocks, bonds or cryptocurrencies that are severely impacted by a volatile or unsecure market.
- Protected, so no impulse spending – those impulse buying sprees can creep up when you least expect them! With CDs you’re protected. Since your money is locked in for a specified time period, you reduce the urge to dip into your savings funds for something that pops up. This keeps your savings plan focused on your goal without wavering.
- But also flexible – although locking your savings account up may sound scary, you are still in the driver’s seat with how you decide to set it up. At the onset, you decide your own timeframe – which typically ranges anywhere from three months to five years. Just remember, the longer term you choose typically translates to a higher interest rate. Depending on what and when your financial goal is in the future, you can coordinate your maturity date accordingly to maximize the return.
- Not permanent (you can take out your funds if needed, but with a penalty) – it’s worth mentioning that if for some reason you need to dip into your CD account, there are options to access your money, although with a penalty. If you decide to pull out money early, a financial institution will typically charge a penalty affecting the interest you have earned. Make sure you check the fine print of your CD and call your financial institution to understand these terms. The key point is that you are not stuck if you need to fall back on these funds.
- You have an option to ladder, meaning more ways to maximize your return – to really maximize your return and access higher rates, CD laddering is a great strategy to take advantage of. A CD ladder allows you to set up multiple CDs so they mature at staggering points in time. Of course, the longer your term of a CD, and the larger your deposit, the more return you will see on your savings. Therefore, when one CD expires you can then reinvest it into a new CD. Here’s an example breakdown of how this works, assuming you had $10,000 to invest:
- $2,000 in a one-year CD
- $2,000 in a two-year CD
- $2,000 in a three-year CD
- $2,000 in a four-year CD
- $2,000 in a five-year CD
After your one-year CD matures, you can then reinvest that money in a new five-year CD. When the second year ends, you can reinvest that money, and so on. Each year a CD matures, you can either continue investing in five-year certificates or withdraw the money (if needed). On the above example and using national averages, if the CD is compounded annually using the CD laddering method, you would earn about $994 in interest, bringing the grand total of your savings to $10,994. On the other hand, if you simply just renewed a one-year CD each year for 10 years, you would earn just $376 in interest. That is, you would gain $618 more by laddering instead of just renewing a short-term CD repeatedly.(2) Note these returns could be different depending on the CD rate and term you sign up with. This example is simply an example to show the compounding effects for laddering CDs.
You don’t have to think about it – everyone is busy with one thing or another, and the last thing you need to have on your mind is how your money is growing. With a CD, you can set it up once and forget about it, and let it do its work for you in the background. All you need to remember is the maturity date and the rate you’re locked into, so you can go tobed every night knowing exactly how much you’ll get back and on what date. With that, you can begin planning how you’ll use these savings and get excited for what’s coming next.
With so many options out there for saving, investing and ideally growing your money, it’s easy to get overwhelmed. Sometimes, it’s best to keep things simple and guaranteed so you can stay on track with your savings and financial goals.