Short-Term CDs: Are They Right for You?

If you want to earn more on your savings without locking it up for years, a short-term certificate of deposit (CD) could be a smart choice. Typically lasting three months to a year, short-term CDs offer guaranteed interest rates that are often higher than traditional savings accounts.

Unlike long-term CDs, which can tie up your money for several years, short-term options provide more flexibility. Although CDs charge penalties for early withdrawals, holding a short-term CD until maturity guarantees your rate and protects your savings. Keep reading to learn how short-term CDs work, current CD rates, and whether they’re the best fit for your financial goals.

What is a short-term CD?

You can generally think of a short-term CD as any certificate of deposit with a term of 12 months or less.

Banks and credit unions commonly offer three-, six- and 12-month terms, though some financial institutions may offer terms as short as one month. In contrast, you may find long-term CDs with maturities of up to 10 years.

A short-term CD — as the name suggests — gives your money less time to grow. Because the commitment is shorter, interest rates are usually lower than those on long-term CDs. But that isn’t always the case, so it’s important to shop around for the best CD rates.

How does a short-term CD work?

A short-term CD works much like any other CD. To open the account, you’ll need to make an initial deposit.

CDs typically allow only one deposit, so it’s worth putting in as much as you can upfront. Some banks set minimum opening deposits, which may be at least $1,000.

A CD is designed to hold money for a fixed period of time. That time is up when you reach your maturity date, after which you can withdraw your funds or renew the account for another term.

Remember to avoid pulling out your money before the CD’s maturity date or you’ll face an early withdrawal penalty unless you have a no-penalty CD.

Policies vary between financial institutions, but early withdrawal fees are usually equal to the interest a CD would have earned over a certain number of months or days. For example, 12-month CDs often have early withdrawal penalties that are equal to three months of interest, which could seriously deplete your earnings.

Short vs. long-term CD rates

Short-term CDs usually pay lower rates than long-term ones, but this isn’t a hard-and-fast rule. In fact, 12-month CDs have often outperformed 2-, 3- and even 5-year CDs in recent years. That means you might lock in a competitive rate without a long commitment.

But the term isn’t the only factor that can affect CD rates. Your rate may also depend on how much you deposit, and CDs with larger balances often earn better returns.

Another key factor in how much interest you earn is your CD’s compounding rate. Compound interest means you earn not only on your initial deposit but also on the interest that builds over time. CDs may compound monthly, daily or less often, but the more frequent the compounding, the more you’ll earn.

To gauge a CD’s total return, look at the annual percentage yield (APY), which reflects the total interest earned based on the rate, term and compounding.

Pros and cons of short-term CDs:

How to choose the right CD term

To choose the right CD term for your needs, consider these factors:

• Financial goal
• Timeline
• Interest rate outlook

If rates are expected to rise, a shorter term may be the better choice. Longer-term CDs often advertise higher rates, but not always — so it pays to shop around.

Short-term CDs work best for near-term goals, such as saving for a vacation, a new appliance or a wedding. For example, if you’re planning a wedding in about a year, a 12-month CD can help you grow your savings while keeping the money accessible when you need it a year later.

Alternatives to short-term CDs

CDs are safe and competitive, but they aren’t the only way to save. If you want easier access to your money, here are some alternatives to short-term CDs.

• High-yield savings accounts: With significantly higher rates than standard savings accounts, high-yield savings accounts (HYSAs) are comparable to CDs, and you can generally withdraw funds without penalty. However, rates are variable and can change at any time. 
• Money market accounts: Combining features of checking and savings accounts, money market accounts (MMAs) typically offer competitive rates along with debit card and check access. But your bank may limit certain monthly transactions, and as with HYSAs, rates can change.
• CD ladders: A CD ladder means splitting your money into multiple CDs with different maturity dates. This approach avoids locking up all of your savings at once and gives you regular access to cash. As each CD matures, you can reinvest and possibly take advantage of higher rates.
• No-penalty CDs: A no-penalty CD lets you withdraw funds before the term ends without paying a fee. However, rates are usually lower than standard CDs, so your overall earnings may be smaller. 
• Short-term bonds: These are generally safe investments that pay interest until the issuer repays your principal on a set date. Because they mature quickly, short-term bonds are less exposed to rate fluctuations than long-term bonds.