Investors looking for a high fixed rate on their savings can consider a Certificate of Deposit (CD). However, note that a CD usually locks up the investor’s funds for a certain period, ranging from a few months to several years. While CD rates offer attractive interest rates of up to 5%, it’s vital to understand that all investments carry some degree of risk. Here are some mistakes to avoid when opening a CD account.
Not considering penalties
Most certificate of deposit accounts require the investor to hold funds in the account until it matures. So, if one takes out money too soon, they might be subject to an early withdrawal penalty. And like other CD terms, the charges may differ based on the financial institution one picks and the length of the CD’s term. For example, if a CD term is lower than 12 months, the investor might be charged 90 days’ worth of interest or more. Moreover, if the account has not earned enough interest to cover the penalty, some financial institutions may take the difference from the principal balance, causing the individual to lose money. Therefore, before opening a CD, one should make sure they understand the penalties for early withdrawal and avoid committing cash that they may require before the account matures.
Signing up for the wrong term
The rate rendered by a CD may vary depending on the term one picks. As of today, the best CD rates are reserved for terms ranging from 6 to 18 months. However, if one opts for a term based primarily on the APY, they may encounter issues if they require the case sooner. Most banks and credit unions charge early withdrawal penalties if an individual takes out money before the term expires. But if one picks a term that’s too short, the original rate may not won’t carry over to the new term. Further, if interest rates go down, one might be looking at lower interest returns.
Not shopping around for rates
Several banks and credit unions offer CDs, but not all accounts have the same benefits. So, while it might be easier to go through one’s current financial institution, one should remember that they might be investing money that gives them a lower annual percentage yield (APY). So, one should take the time to research the top CD rates across banks and credit unions to ensure they get the most for their savings. The investor should also check for minimum deposit requirements to ensure they qualify for the account based on how much they intend to save.
Forgetting to withdraw at the end of the term
While one might invest in the ideal CD, one often forgets to withdraw the money at the end of the term. An individual usually gets seven to 10 days to renew the account for another term or to withdraw the funds. Moreover, a bank or credit union is required by law to notify the investor ahead of the maturity date. So, if one forgets or does not make a decision to withdraw in time, the financial institution may automatically roll over the funds into a new CD. This might compel one to keep the money in the account for longer than planned or to take an early withdrawal, which may incur an unnecessary penalty.
A single CD is a great way to earn high APY on savings. But putting all the money into one could cause problems if the individual experiences a financial emergency. One could keep some of their savings in a high-yield savings account or money market account so they will have cash easily accessible when it is needed.
Playing it safe with cash
A CD offers a guaranteed, safe return on one’s money. However, based on one’s current financial situation and goals, it might be better to invest some of the cash instead of putting it in a CD. While the stock market might be volatile in the short term, and there’s a risk of losing some of the money, it might be a better place to invest money for long-term needs and goals.
Picking the incorrect CD type
Various types of CDs offer special features. One should stick to a variety of types and understand the pros and cons of each.
- A standard CD does not offer any special features. When an individual deposits money and holds it until the account matures, there is no change in the interest rate during that period. Early withdrawals usually result in penalties, and the terms of the CD may range from one month to 10 years.
- A no-penalty does not charge the investor if they need to withdraw funds before the account matures. Terms are typically around 12 months or less, but some institutions may offer longer terms.
- A step-up CD is where the account’s interest rate increases in regular intervals over the term. For instance, one might have a 28-month term with a rate that increases every seven months.
- People who invest in a bump-up CD benefit when interest rates rise over time. The CD allows users to raise the interest rate on the account once during its term to take advantage of rising APYs.
- A brokered CD is offered by a brokerage firm instead of a bank or credit union. The investor might be able to secure a term of up to 30 years with a brokered CD. Furthermore, since brokers can hold accounts at multiple banks, one might be eligible for a higher FDIC insurance coverage limit. The individual can also sell a brokered CD on the secondary market if they want the money before the account matures. However, one should note that the value might rise or drop based on market rates.
Lastly, no-penalty, step-up, and bump-up CDs usually offer lower interest rates than standard CDs. However, one can get a higher APY with a brokered CD than a CD offered by a bank or credit union.