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Which CD Term Length Should You Choose?

Banking, Banking Basics, CDs
Which CD Term Length Should You Choose?

A couple of clicks is often all it takes to transfer cash from your savings to your checking account. While this can come in handy when, say, your dishwasher suddenly gives out, regularly dipping into savings can hurt your long-term financial goals. Emergencies are one thing; nights out are another.

“If only there were a savings account that could protect me from myself,” you might be thinking.

Good news: Such accounts exist. They’re called certificates of deposit at banks and share certificates at credit unions. The deal is you commit to leaving your money in one for a set period of time. In return, you’ll get a better interest rate than you’d get on a regular savings account. Plus, the temptation to dip into that money is dampened by the penalty you’d incur by making an early withdrawal.

The trick, then, is finding the right balance between having your money accessible and letting it grow. CDs can be great tools to help you achieve your overall savings goals, as long as you take the time to find the best rates and avoid early withdrawal fees. Here’s what to keep in mind when choosing a CD term length.

Little commitment but tiny rates

Short-term CDs (3-12 months)

Securing a CD with a high interest rate and avoiding early withdrawal fees should be your main priorities. Short-term CDs make the second goal possible. But the first? Almost impossible. Bank-issued, three-month CDs come with an average annual percentage yield of just 0.08%. That’s about the same as what you’d get on a basic savings account. At online banks and credit unions, you may find three-month CDs with APYs closer to 0.30%.

At banks, rates on six-month CDs aren’t much better — 0.13% on average. You may find better APYs at online-only banks and credit unions, which tend to be in the ballpark of 0.50%, but remember that the same institutions might also offer a high-yield savings account. That may serve you better than a CD, unless you purposely want to make it difficult to get at your savings.

If you’re simply looking to set aside a certain amount of money and want to ensure that you won’t spend it, a three- or six-month CD could be right for you. Knowing that you’d be penalized for withdrawing that money early might be exactly the motivation you need to leave it alone.

» Learn more about CDs by reading our explainer, What is a CD (certificate of deposit)?

Better rates but more discipline required

Mid-range CDs (1-3 years)

With a one-year CD, you’ll have to work a little harder to stay disciplined and not withdraw your funds prematurely. In exchange, you’ll receive a slightly better rate. The average APY for a one-year bank-issued CD is 0.21%. But again, a few online-only banks and credit unions offer more, with one-year CD rates above 1%.

Just be sure that you won’t need to access that cash. Having a separate emergency fund can help. This rainy-day fund should contain three to six months of living expenses. With that in place, you won’t be as tempted to dip into your CD.

Best rates, if you can handle the commitment

Long-Term CDs (4-5 years)

If you’re handing over your money for up to five years, you’ll want a stellar rate in return. Once again, credit unions and online-only banks will be your best bet, with some offering long-term CD rates as high as 2%. Bank-issued five-year CDs, meanwhile, have an average rate of only 0.78%.

Keep an eye out for online-only banks and credit unions that don’t have minimum balance requirements. That way, you won’t be forced to put away more money than you can afford. And, if you’re putting away money for up to five years, you might want to consider investing in a “bump-up CD,” a special type of certificate that lets customers take advantage of rising rates in the market.

» Want to explore the top offers? Browse our best CD rates list

How to bridge the gap

Build a CD ladder

Many savers may want the higher rates of a three- to five-year term but are wary of tying up their money for such a long time. CD ladders help to address this issue. The process is fairly simple: Instead of putting, say, $10,000 into a five-year CD, put $2,000 each into a one-, two-, three-, four- and five-year CD. You can use our CD tool to find varying term lengths and rates.  As each CD matures, reinvest the money in a new five-year CD, and before long you’ll have one five-year CD maturing each year. This way, you enjoy the highest possible interest rates but still have some of the funds available in the short term.

Tony Armstrong is a staff writer at NerdWallet, a personal finance website. Email: Twitter: @tonystrongarm.

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