CLEVELAND, Ohio – Certificates of deposit and online savings accounts used to offer little to no interest. But with interest rates on these products hitting 4% and even 5%, it’s now a legitimate question. Should I buy a CD?
It’s enticing. Although, there are plenty of reasons to put your money somewhere else.
“You can’t ask a financial advisor a question without them answering ‘It depends,’” said Ken Robinson, owner of Practical Financial Planning in Rocky River. “But the reason for that is that one size never fits all.”
At the time of publication, you could find high-yield savings accounts with a 4% APY (annual percentage yield). CD rates vary, but some of the best offers are now topping 5% APY.
A certificate of deposit, often shortened to CD, is essentially a savings account that holds onto money for a fix period of time. In exchange, you get a guarantied rate of return.
You’ll often see two terms when shopping for CDs; the interest rate or the APY. What’s the difference? Well, the same interest rate will earn a different amount of money if its compounded daily, monthly or even quarterly. An APY takes this compounding into account and represents your actual rate of return in one year’s time.
The bank near you probably won’t have CDs or savings accounts with these high of rates. The lucrative offers are on online-only products. And while some brick-and-mortar banks locally have upped their game, many aren’t.
My bank account earned just 92 cents over the last three months, not even enough for a candy bar.
Clearly, not everyone is raising their rates. But some are competing hard for your deposits.
Why? Greg McBride, chief financial analyst for Bankrate.com, said the change in rates is best explained as supply and demand.
The Federal Reserve has been raising interest rates to combat inflation, which in turn is making debt more expensive. Banks can make more money on loans, but they need deposits to make those loans.
If you want more deposits, you entice people by offering better interest rates. That’s likely why the average one-year CD rate was 1.47% in February, up from 0.34% last year, according to Bankrate.
It’s nothing like the 1980s, when people could find CDs with double-digit rates. Yet it’s high enough to pique my interest.
But since savings account are not far behind, even now it may not be worth it.
For math’s sake, let’s say we have $5,000 to spare.
The CD will make $301.69 in interest over 14 months, while the savings account would make $254.66. That extra $50 comes with pros and cons.
Buying a CD, generally, means that your money is locked up for 14 months. Withdrawing money from an online bank isn’t as quick as visiting an ATM — but it usually only takes a few days.
On the flip side, buying a CD will lock in your interest rate. But the rate on a savings account can change.
McBride said it’s hard, if not impossible, to predict when rates will change. The Federal Reserve could raise rates to fight inflation next month. But if a recession hits in six months or a year, they could end up lowering rates. It’s all a guessing game.
This illustrates the problem. There are plenty of things to do with money, but everything has pros and cons. You could save for retirement. You could pay off debt. And to be honest, you could probably do a lot to improve your quality of life by just buying something.
If you’re used to stashing away money, you probably overanalyze ways to spend it — which is why I’ve left too much of it in a little-to-no-interest savings account.
I ran through these options with Robinson, of Practical Financial Planning. He didn’t have one-size-fits-all advice, but he did have one good thing to keep in mind: You don’t need perfect, just good.
“You don’t have to do the very best thing as long as you do something that’s helpful,” Robinson said.
There are plenty of helpful things to do with money. Buying a CD or putting money in a high-yield savings account are just some of them. Here are a few different routes.
An emergency fund
If you don’t have an emergency fund, start one. Take it from the guy who had a furnace and refrigerator break down in the same month. One of the best things money can buy is security.
That doesn’t mean you can’t put your emergency fund in a high-yield savings account or even a CD under the right circumstances. But you should generally have anywhere from three to six months of expenses available for unforeseen expenses.
Why a CD for emergencies? Well, some CDs have no penalties for early withdrawal. And even if they do, Robinson argues that a little bit of friction is good. It stops you from taking out the money unless there’s a true emergency.
Paying off debt?
Should you pay off debt or buy a CD? It depends on which kind of debt.
If you have credit-card debt at a high-interest rate, like 18%, paying it off should be a priority.
A mortgage is a different story. Some homeowners have refinanced at about 3% in the last few years. Others are buying homes right now at an average rate of 6.43% on a 30-year loan.
Plus, you don’t necessarily see the benefits of paying off a mortgage right away.
I bought a home last summer with a 30-year, 4.89% loan. Every extra $1,000 I pay today would save me $3,140 in interest over the life of the loan. It would shave off about four months of payments — in 2052.
Amortization, the math behind your mortgage payment, is tricky. Paying an extra $5,000 now would mean more of each monthly payment goes toward principal instead of debt — so there are immediate benefits. But suffice to say, there are reasons to look at other options.
Put extra in a 401K
It’s sound advice to put a percentage of each paycheck in a tax-advantaged retirement account, like a 401K or IRA. But if you’re considering a CD, maybe you should park money in your 401K.
A CD gives you small, but guarantied returns. And you get your money back sooner.
Investments are volatile in the short term, but most likely will out-earn CDs in the long term.
Say you have an extra $3,000. Instead of putting $200 toward your 401K each paycheck, maybe you put in $250 for a year.
You might not see this money for decades, depending on your age, but you could argue that it’s a sounder investment than a CD or paying off your mortgage.
Sometimes you should hold onto cash, but other times, I’d argue it’s more valuable to spend it. Especially if you’re a person who saves money by putting off purchases for as long as possible.
Maybe your lawn mower is 20 years old. Or maybe you bake a lot, and a stand mixer would save you time.
Spending more is obviously not a way to “save you money.” But a good pair of boots usually lasts longer than a cheap pair. I’m guilty of almost always buying the cheapest thing — and sometimes regretting it.
There’s a big difference between paying $6 for a smoothie every day or buying a good blender. There’s a debate in the middle.
But if you put $1,000 into even the best 14-month CD, you’ll make $60. I’d argue putting that toward a good mattress is a better bet.
Where do you find a good CD or high-yield savings account?
Whether you’re creating an emergency fund or are saving to buy a vehicle in cash, both CDs and high-yield savings accounts can be tools in your arsenal.
While the best rates are from out-of-town banks, ones you’re more familiar with also have good deals — even if they’re online only.
At the time of this writing Citizens Bank has an online account with 4.25% APY, and we’ve already mentioned the Third Federal account with 4.3% APY.
It’s not on either the Bankrate or NerdWallet lists, but Huntington Bank is offering a 14-month CD with 5.18% APY. Fifth-Third has some CD options from 4% to 4.55% but they need large initial investments.
Read past columns at cleveland.com/topic/saving-you-money/.