If you have some cash that you would like to put to work and are ready to do so by purchasing a Certificate of Deposit (CD) – congratulations! We love when people use their money wisely and profitably.
Selecting a CD as a return-generating investment, however, is only the first step. You also need to decide on a CD term. Whether you consider short-term and long-term CD options depends on your specific needs. It also depends on how long you are willing to lock in your money. CD durations can last from one month to five years and beyond. The right one for you might not be the one with the best CD rates.
Read on to learn some CD basics to weigh the benefits of a CD in the short term versus the long term.
What is a short term CD?
CD durations tend to vary from three months to five years, although there are increasingly longer durations on either side of this duration. That is why it is a good idea to check out both short term and long term CD options.
A short term CD has a duration of three to 12 months. Shorter CD terms generally offer a lower interest rate due to the short term commitment.
What is a long term CD?
A long-term CD is on the opposite side of the spectrum from its short-term sibling. Although some issuers have different criteria for what constitutes a “long term,” the generally accepted term range for this category is four years or more.
How do CDs work?
A CD is a deposit account offered by banks and other financial institutions. CDs have always been a popular savings option because they offer guaranteed returns.
Standard CDs pay a fixed annual rate of return (APY) when they mature – as long as you keep the money in the account and don’t withdraw funds. If you do, you will be hit with an expensive early withdrawal penalty. These penalties can sometimes exceed the return you would have earned if you had kept that money in the account.
Over the years, variations on the traditional CD have hit the market. “Bump-up” and “step-up” CDs offer holders the opportunity to get an increase in APY if interest rates go in the right direction. In addition to these features, they are more or less standard CDs.
Several vendors offer CDs that offer withdrawal options without penalty. These usually have lower APYs than regular CDs because of this.
For the most part, however, investing in a CD is a commitment of funds. In return for keeping your funds locked up, a financial institution usually offers higher APYs than other savings products. These include offers like a savings account or a money market account, which allow a certain degree of transfer and withdrawal of funds without penalty.
A CD is considered one of the safest financial instruments for determined savers. Plus, like other bank accounts, most CDs are fully covered by the government’s Federal Deposit Insurance Corporation (FDIC). Up to $ 250,000 per person per account is automatically covered by this coverage.
Why are CD APYs higher than other deposit accounts?
APY CDs are higher because you agree to deposit your funds and not touch them for a specific time. This allows the banks to use that money for a predictable amount of time. Early withdrawal penalties are a great discouragement for withdrawing money from a CD, so the money tends to stay where it is. In general, the more stable and predictable a set of funds, the higher the price an investor is willing to pay.
Following the same principle, the longer a bank can use this money, the more it is willing to pay. This is why APY CDs tend to increase with the length of terms. Keep this in mind when looking at short term or long term CD accounts.
Here’s an illustration of short-term and long-term CD rates, with a sample of fairly typical recent YPAs: