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Retirement Savings: How Much Should I Save Each Month?Short vs. Long-Term CD Rates: What to Choose
Short-term certificates of deposit (CDs) are, on average, offering higher annual percentage yields (APYs) than long-term CDs, according to data from the Federal Deposit Insurance Corp. (FDIC). This isn’t typically the case when you look at short- vs. long-term CD rates.
Better rates on short-term CDs reflect the expectation within financial institutions that the Federal Reserve will cut interest rates. As a result, banks and credit unions don’t want to lock in high rates on long-term products. Still, you’ll need to weigh your financial priorities when choosing a CD term.
What is a short-term CD?
Generally, you can think of a short-term CD as any CD with a term of 12 months or fewer. You can even find CDs with terms as short as one month. In contrast, long-term CDs can offer terms of 10 years or longer, though typically you’ll see terms between three and five years.
Aside from term length, all CDs share some important traits. For instance, you can expect to see higher interest rates than those available on standard savings accounts. Plus, as long as your bank or credit union is federally insured, your CD will be covered by deposit insurance worth up to $250,000.
The FDIC, which averages rates on CD products at $10,000 and $100,000 tiers, most recently measured CD rates in late April. All of the short-term products had better rate averages than the long-term products, with one exception: 1-month CDs had a low average rate.
Short- vs. long-term CD: Which should you choose?
Pros and cons of short-term CDs:
PROS
- Offer a safe savings option with competitive returns
- Create a productive way to set aside money for shorter-term expenses, such as vacations or retail purchases
- Guarantee a rate of return during your term
CONS
- Limit your access to funds deposited in the CD
- Provide limited return stability because your rate can change at the end of your term
- Usually feature lower interest rates than long-term CDs, except in the current rate environment
Pros and cons of long-term CDs:
PROS
- Offer a safe savings option with competitive returns
- Usually provide higher interest rates than short-term CDs
- Ensure return stability as your rate won’t change during your term
CONS
- Limit your access to funds deposited in the CD for a period of three years or more
- May result in a less-than-ideal return if rates rise after you open an account
- Tend to have lower interest rates than short-term CDs in the current rate environment
How to choose the right CD term
When you choose a CD term, make sure you’re comfortable with losing access to the funds you’re depositing for the entire length of the CD. If you cash in your CD before the term ends, you’ll face early withdrawal penalties, which can be steep.
The right choice for you could also be choosing more than one CD term. For example, you could build a CD ladder, which involves dividing your funds among a handful of CDs with staggered terms.
With this approach, you’ll avoid locking up all of your savings for the same amount of time. You also won’t tie all of your funds to the same interest rate.
Should you lock in CD rates now?
Now is a reasonable time for investors to lock in a rate on a short-term CD. However, focus on certain CD terms.
“I probably wouldn’t go much beyond a year at this point just because you can get the best rate at nine months to a year’s CD term,” says Dan Honsberger, a certified financial planner and founder of Reel Financial Planning.
Long-term CD rates could be more appealing after a rate cut by the Fed. In that environment, financial institutions may once again decide to encourage savers to open longer CD terms by offering higher APYs on those products.
Opening a short-term CD account now could also be preferable to keeping your funds parked in a high-yield savings account (HYSA).
“At this point, I would probably choose a CD over a high-yield savings account if … you’re OK to lock up your money for nine months to 12 months,” Honsberger says. “It protects you against maybe the Federal Reserve dropping interest rates, which would flow through and reduce your high-yield savings account interest pretty quickly.”
How to find the best rates
Some of the best CD rates come from providers such as BCU, Colorado Federal Savings Bank and Communitywide Federal Credit Union. You should check rates with multiple providers before making your choice, and make sure to keep your eye out for offers that seem too good to be true. This could be a sign of a disreputable company.
What to do if interest rates rise after you invest in a short-term CD
If interest rates rise after you invest in a short-term CD, you don’t have to do anything in particular. If you have extra funds and you’re looking for a new CD account, be sure to compare rates across different term lengths.
As for the funds sitting in your short-term CD, you’ll want to leave them there. Withdrawing before the end of the term can lead to an early withdrawal penalty that likely won’t be worth it for whatever gain you’d get by moving the funds into a higher-rate account.
Once the short-term CD matures, you can choose what to do with those funds next.
Are there penalties for early withdrawal from a short-term CD?
Yes, financial institutions charge penalties for early withdrawals from short-term CDs. Under federal law, the minimum early withdrawal penalty for making a withdrawal within six days of depositing your funds is at least seven days’ worth of simple interest.
Beyond that, the penalty amount can vary by institution. For example, Bank of America charges 180 days’ worth of interest as a penalty for early withdrawals on CDs with terms between 12 and 60 months.
What to consider before opening a CD
Before opening a CD, consider some of these factors:
- Savings goals: If you’re saving for a discrete purpose in the near future, such as a trip or a wedding, pick a short-term CD that lets you regain access to your funds — with interest — before your planned expense.
- Willingness to take risks: CDs are safe, but that safety can mean lower returns than you could get with riskier investment products, such as stocks and bonds.
- Available rates: You’ll want to rate shop and find a product that offers a return you’re comfortable with before you commit.
Alternatives to CDs
The best option for you outside of a CD will depend on factors including your risk appetite and how accessible you need your funds to be. Options include:
- HYSAs: With an HYSA, you’ll have easy access to your funds. But your rate may be lower, and it’ll be more sensitive to any adjustments to the federal funds rate.
- Money market accounts: A money market account provides more flexibility than a CD, with easier withdrawals and often better rates than a standard savings account.
- Bonds: Investing in bonds comes with more risk than saving with a CD, but your potential return is also higher.
Frequently asked questions
Is a 3-month CD worth it?
A 3-month CD can be worth it if you have funds you’re willing to part with for that amount of time and you can find a satisfactory rate.
Why choose a short-term CD over a savings account?
A short-term CD can be better than a savings account because it will typically offer a higher APY for a fixed period.
Should you build a CD ladder?
If you’ve been comparing short- versus long-term CD rates, a CD ladder can help you get the best of both. This could mean distributing $10,000 between four CDs with different term lengths — nine months, 12 months, two years and four years. “Let’s say interest rates come way down after you set up this ladder,” Honsberger says. “You’re better off having done that than if you put all $10,000 into a 12-month CD.”