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Dorchester Center, MA 02124
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By O1ne Mortgage
A certificate of deposit (CD) is a low-risk investment that allows you to earn interest on your money. Rates vary from one financial institution to the next. The term length can also affect your rate, but a CD typically pays more interest than a traditional savings account. That can make it a great place to keep a portion of your savings. Understanding how CD rates are calculated can help you maximize your investment and get the most out of your money.
Interest rates on CDs and savings accounts are both influenced by the federal funds rate, which is set by the Federal Reserve. This rate sets the tone for what banks and credit unions offer on deposit accounts. When the federal funds rate increases, annual percentage yields (APYs), or the rates bank accounts pay, tend to go up too. CD interest rates are generally a few points higher than the Fed rate.
CD interest rates vary but some currently exceed 5%. Compound interest will also work to your advantage with a CD. It allows you to earn interest on your original investment and your accrued interest. That means faster growth and better returns. CD rates are usually compounded monthly or daily. The more often compounding happens, the better.
Let’s say you put $5,000 into a CD that compounds monthly and earns 5.12%. After 60 months, your earnings would exceed $1,400 if you left your money untouched. That number gets slightly higher if interest compounds daily.
A high-yield CD offers a more competitive interest rate than other CDs. They’re more common among CDs that have longer maturity periods. For example, a five-year term will likely offer a better rate than a one-month term. Of course, that means giving up access to your money for a longer period of time. Some high-yield CDs also have minimum opening deposits that may be as high as $5,000.
One way to maximize CD returns is to spread your money between two different accounts—one long-term CD and one with a shorter term. This is called a CD barbell, and it allows you to benefit from long-term rates without sacrificing liquidity for quite as long. When the shorter term ends, you can reinvest that money or put it toward more immediate financial goals.
Another option is CD laddering. This involves staggering your money across multiple CDs with various term lengths. That way you’ve always got some money earning interest. It also provides a continual cycle of available cash. This adds a layer of flexibility. Some CDs may require a minimum deposit, so you might need a larger upfront investment. CD laddering can also get tricky if you’re managing multiple accounts across different banks and credit unions. Be aware that some CDs will automatically renew if you don’t pull your money out soon after they mature.
CD interest rates vary depending on the financial institution and term length. Having said that, CDs are considered safe, low-risk investments. They’re ideal for financial goals that have a shorter time horizon, like a home down payment or family vacation. If you’re saving for something that’s further down the road, such as retirement or your kids’ college education, you could get better returns with the stock market. The risk is higher, but there’s more time to recover from market swings.
In the meantime, prioritizing your credit can only help your financial health. Check your credit report and credit score for free with Experian to get started.
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