As the Federal Reserve has recently signaled its readiness to start reducing interest rates, many consumers are turning to certificates of deposit (CDs) as a way to lock in today’s high rates for a longer time. It’s not a bad strategy. Short-term CD rates have already started to decline, and there’s no telling how much more they could fall if the Fed outlines a clearer path forward at their next meeting.
Of course, since CDs do impose penalties, you’ll want to create a strategy to help you maximize your returns. With that in mind, let’s look at three ways to harness today’s best CD rates without your plan backfiring.
1. Get a no-penalty CD
No-penalty CDs give you the option to break your CD contract early without incurring penalties or fees. This can be a savvy option for those who don’t have a lot of savings but want to lock in high rates while they still can.
Early withdrawal penalties on CDs can be severe. Often, the penalty is equal to a period of interest, whether you earned it or not. For example, a 12-month CD may have a withdrawal penalty equal to 90 days of interest. If you were to withdraw after 60 days, you would still pay 90 days of interest, thus resulting in a loss.
Traditionally, no-penalty CDs weren’t worth the investment because their APYs were so low. But, with today’s high rates, you can find many no-penalty CDs that are on par with those that impose a penalty. For a good example of this, check the financial platform Raisin, where the highest no-penalty CD is currently paying out at 5.40%. For comparison, the highest regular CD is paying out at 5.51% — only slightly higher.
2. Build a CD ladder
No-penalty CDs do have a major weakness: Most have short terms, like five months, making them poor investments for those with longer time horizons. If you want the flexibility of a no-penalty CD, but you’d like to lock in today’s high rates for longer, you might be better off building a CD ladder.
A CD ladder involves dividing your money into equal lump sums and investing them into CDs with staggered terms. For example, if you had $25,000 in savings, you could invest your money like this:
This would be different then, say, investing $25,000 in a 2-year CD. Between the two scenarios, the interest you earn might be similar, but the 2-year CD would require you to wait 24 months before you could access money, while this specific CD ladder would ensure you’re never more than six months away from withdrawing a portion of your savings. It gives you peace of mind, while also giving you a plan B should you encounter an unexpected expense.
3. Get a brokered CD
A brokered CD is a type of CD contract that’s only available through a brokerage account. In this case, the broker isn’t the CD issuer but rather buys them in bulk from CD providers, like banks, then sells them to its customers. A few examples of brokered CDs include:
Brokered CDs don’t usually allow early withdrawals, not even if you agree to pay a penalty. Instead, you must sell your CD on a secondary market, much like a stock or ETF. This involves finding a buyer who will take the CD off your hands.
Like other investments, this could result in a loss, especially if CD rates have increased since you purchased yours. But since rates appear as if they will decrease in the near future, buying one of today’s top-paying CDs and selling it later could result in a significant gain. There’s no guarantee that you’ll make money, but if you have an appetite for risk, it’s certainly an interesting strategy to try.
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