Ask a Nerd: When and Why Should I Open a CD?

Certificates of deposit are having a moment, but they’re best for specific savings goals.
Spencer Tierney
By Spencer Tierney 
Edited by Sara Clarke

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The year 2022 has not been kind to our wallets. But amid rising prices (i.e., inflation) there’s at least one perk: Savings account rates have increased, including on certificates of deposit.

Some CDs have returns upward of 3% right now, but like any bank account, they don’t work for every financial situation. Let’s see if CDs make sense for you.

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Quick definition: CDs that hold money, not music

If you came to this article thinking of a CD as in a compact disc for music, I apologize — but good luck with your old-school music collection.

In banking, a CD refers to a certificate of deposit, which is a type of savings account that has a fixed term and fixed interest rate. You add money, wait for the CD’s term — usually three months to five years — to end, and get your money back with interest.

The main places to open CDs are banks and credit unions, which are banks’ not-for-profit counterparts. Credit unions tend to call CDs “share certificates.” Brokerages also offer CDs, but the process is more complicated and requires an investment account.

CDs: The good, the bad, the penalty

The good

Here’s the biggest reason to consider CDs: They can offer the highest guaranteed returns for a bank account. And current CD rates are some of the highest in a decade, based on NerdWallet analysis of Fed data and its own data. When the Federal Reserve raises its rate, as it has multiple times in 2022, banks usually raise their savings and CD yields.

Hands down, the best rates are at online-only institutions. At the time of writing, you can find rates for one-year CDs above 2.3% annual percentage yield, three-year CDs above 2.7% APY and five-year CDs above 3% APY. The national average CD rates, in contrast, are below 0.70%, which is still better than the national average of 0.13% on regular savings accounts.

Take this scenario: Put $10,000 into a CD at 3% for a five-year term, and you’ll earn around $1,600 in interest. Try that same amount and time frame but in a savings account with a 0.13% rate, and you'll earn about $65. I’d choose the first option.

Unlike some checking or savings accounts, CDs don’t have monthly fees or minimum balance requirements other than a minimum amount to open. High-yield CDs have minimums that range from $0 to $10,000.

The bad

CDs are the bank account equivalent of a lockbox. In exchange for high rates, you give up access to funds. The first time you add money is nearly always the only time you add money, so you have to be OK with transferring a decent sum of cash into an account upfront. Then your money gets locked up for the CD term you choose.

The penalty

If you need to cash out a CD early, well, it might hurt. You must withdraw all the money in one transaction and almost always pay a penalty that can cost several months’ to a year’s worth of interest you earned — or would’ve earned. A bank can dip into your original amount to cover a penalty. Unlike other bank accounts, though, CDs only have this one potential cost, and you can avoid it by waiting for a CD to mature.

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When would CDs work best for me?

CDs have more specific use cases than your everyday checking and savings accounts. Ask yourself any of these questions before deciding to open one.

1. Do I need more distance from some savings?

Say you come into an inheritance or other type of windfall; or you’ve built up savings for years; or, you’re like my parents who — as I grew up — put some savings in a share certificate to keep it out of reach. Whatever the reason, a CD is built to keep you from being tempted to spend those funds.

2. Do I have savings earmarked for a big purchase?

If you have a sum intended for a car or down payment on a home in the next few years, a CD helps you set aside the funds until you’re ready.

3. Do I want to protect some wealth outside of investments?

CDs provide short-term safety, not long-term growth. Funds are federally insured as they are in other bank accounts, meaning your funds get returned to you even if a bank goes bankrupt. CDs also don’t have the risk of fluctuation in value as in the stock market.

CDs “sit in the middle ground between emergency savings and investing,” says Derek Brainard, national director of financial education at the AccessLex Institute, a financial literacy nonprofit.

Essentially, CDs are cash reserves for short-term goals. Emergency savings should be immediately accessible if they’re needed, while investing — such as in stocks or bonds — is for accumulating wealth in the long term, Brainard explains.

What if CDs aren’t right for me?

Giving up the thought of high CD rates might be hard, but maybe you realize that losing access to funds isn’t worthwhile. You can still take advantage of the rising rate environment by opening a high-yield savings account. Like high-yield CDs, these accounts are mostly available at online-only banks and credit unions. Many have rates close to 2% APY right now, and you can add or remove money at any time.

I want a CD, but what if CD rates increase?

A CD’s fixed rate can be a double-edged sword: It provides guaranteed returns, but if rates rise, you lose out on higher rates after you lock in yours. And rates have been increasing lately.

“If you do believe the rising rate environment will continue, one strategy to offset that risk is certificate [or CD] laddering,” says CJ Pointkowski, assistant vice president of savings products at Navy Federal Credit Union.

Laddering CDs, or creating a CD ladder, involves opening multiple CDs of different terms — generally short, midrange and long terms. A common ladder consists of one- through five-year CDs where five CDs mature at staggered intervals, such as every year for the next half decade. When each CD ends, you can reinvest in a new five-year CD to take advantage of higher future rates — or you can withdraw the cash.

If juggling multiple CDs sounds like a hassle, another strategy is to open a no-penalty CD. This less-common type of CD allows for a free early withdrawal at any point after the first few days, which removes any barrier of switching to a higher-rate CD later. But rates alone shouldn’t guide your decision to open a CD.

"At the end of the day, a CD is either going to be the right tool or not, regardless of what’s happening in the interest rate environment,” Brainard says.

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