Here's Why It Doesn't Always Pay to Buy a CD With the Absolute Highest Rate

CDs are paying competitive yields right now. So if you’re looking to earn a good return without taking any risk, you may be interested in investing in one. If you are, chances are good you’re hoping to maximize your return on investment (ROI), so of course you’ll be looking for the most competitive rates.

This makes good financial sense. A high rate is better, because who doesn’t want to earn more money?

But as you explore your options, you may discover that you don’t want to invest in the certificate of deposit offering the absolute highest possible yields every single time. Here’s why.

You need to look beyond interest rate alone

The APY (annual percentage yield) a particular CD offers is just one of several factors to consider when you make your investment selection.

If you only focus on rate, you could end up making the wrong investment. Here are a few other things that need to be given equal — or greater — weight.

The CD term

The CD term is arguably the absolute most important factor in a CD, even above rate. The term determines:

  • How long you must keep your money tied up
  • How long your rate is guaranteed to last

If you were just choosing a CD paying the highest possible rate, right now you’d most likely be looking at a CD with a term of around one year or less.

A quick look at The Ascent’s list of the best CD rates shows some 12-month CDs paying upwards of 5.00%. There are also some great 6-month CDs with rates above 5.00%. On the other hand, the best 5-year CD rates are generally in the mid-4.00% range in terms of yields.

But choosing a 6- or 12-month CD based solely on its competitive ROI may not be the right bet. If you think interest rates are going to go down soon and you want to lock up a high rate for as long as possible, you likely should open a 5-year CD, even if you have to accept a lower rate to do it.

On the other hand, if you have money you can only tie up for six months, you’d want to opt for a 6-month CD rather than a 12-month one, even if the 12-month CD pays a higher yield.

The minimum required investment

The minimum investment required is also just as important as the CD’s APY. The reason for this is obvious. It doesn’t matter how much better the rate is on a CD with a $2,500 minimum investment requirement if you only have $1,000 to invest.

Now, it may be tempting to try to stretch to open a CD with a better rate that comes with a higher minimum investment requirement. But you don’t want to take a chance of locking up money that you can’t really afford to commit for the duration of the CD term. If you do and you end up having to take the money out early, you could face hefty early withdrawal penalties.

Fortunately, there are plenty of CDs with no minimum balance required to get started. Opting for a CD you can easily afford makes a whole lot more sense than putting yourself at risk by investing money you aren’t 100% sure can stay in the CD until it matures.

So, when you open a CD, you do want to consider yield of course. But if an option with a higher rate isn’t really affordable or available for the right duration, then accepting a lower rate for a CD that’s a better fit for you is the smarter move.

These savings accounts are FDIC insured and could earn you 11x your bank

Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts could earn you 11x the national average savings account rate. Click here to uncover the best-in-class accounts that landed a spot on our short list of the best savings accounts for 2024.

Source link

About The Author

Scroll to Top