Guest blog post by Roberta Pescow, NerdWallet
With interest rates still hovering near historic lows, traditional savings accounts just don’t offer significant growth potential for your money. As the Federal Reserve takes steps to tighten up, rates are widely expected to march higher starting sometime next year, and that makes the prospect of locking in long-term investments at today’s returns less appealing. The situation can also make short-term certificates of deposit (CDs) more attractive as a way to earn more today without sacrificing liquidity once rates begin rising.
Understanding short-term CDs
A CD is federally insured and typically provides a guaranteed interest rate in return for investing a set amount of money for a fixed time period. Generally the longer the term, the higher the interest paid. But taking out money early usually results in penalties.
A short-term CD generally matures in up to a year. While they earn less than longer-term counterparts, they still offer higher annual yields than traditional savings accounts. Currently the national average yield for a six-month CD with a balance of under $100,000 is 0.12%. Although this may not seem like much, it’s twice the average annual percentage yield (APY) of 0.06% for savings accounts, making the benefit of short-term CDs apparent. Some banks pay significantly more.
Locking in funds for up to a year brings the added advantage of freeing up money fairly quickly in a climate where interest rates may climb. Once the CD matures, odds are the money can be reinvested at a more favorable rate.
Before purchasing a short-term CD, it’s important to be sure you won’t need those funds before the maturity date, or you may face early withdrawal penalties that can easily cancel out any earnings. Many institutions require minimum deposits of $500 or more for CDs. While each financial institution has its own policy regarding penalties, cashing in early could result in the loss of three months of interest and possibly some of your principal as well.
Keeping a separate, liquid emergency fund is a sound strategy when locking in other investments. Be sure this fund has enough to cover a temporary loss of income, an unanticipated medical issue or other unforeseen challenge for at least the length of the CD term.
The bottom line on how you can use short-term CDs
Short-term CDs are an excellent way to increase interest earnings and still be ready to corral better investment opportunities in the not-too-distant future. As long as you won’t need to tap into funds before the end of the term, a short-term CD may be a good savings strategy.