638 - Should I Use a High-Yield CD for My Savings?
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Who's been producing the show since two thousand eight my personal mission and the purpose of this podcast is to give you the knowledge resources and motivation to manage your money the best way possible and create a richer life if you haven't been to the money girl section over at quick and dirty tips dot com. That's where you can find the show notes. The complete archive of podcasts. All my books and many other great resources today is episode number. Six hundred thirty eight called. Should I use a high yield? Cd for my savings. And we'RE GONNA kick it off with a recent voice mail that I received from Anna in Washington. Dc Hi Laura this is Anna calling from Washington DC. Thanks for putting out a great show. I've been listening to your podcast for several years and your straightforward advice and information has been any good money decision. I share your work with everyone. I know WHO's my question? I keep the majority of my savings and a high yield savings account that at one time offered a one point seven percent. At why are my savings? However do the Federal Reserve lower interest rates in response to the economic impacts of the covid nineteen pandemic thank recently reduced rate. They offer to customers to one point. Five five percents and now even less at one point. Three percent eighty one. This is obviously frustrating for me as a customer. But I understand that a lot of this outside of anyone's control and these trying times however does financial institutions offering for customers. You use a CD which earns a one point five percent API this seems attractive given the additional boost. However I'm not really sure what the pros and cons are for D.'s. And to be honest I'm not exactly sure. What a C. D. is it's helpful for context. I keep my six months emergency fund savings in this of eighty account. And I'm trying to save her down payment on a house. I of course not my emergency fund should be readily available getting these for in times. But I probably won't need to touch my downpayment savings for at least another year or two or maybe more says the housing market is very expensive in the DC area does moving my money to a CD. Make sense or should I just keep it in the high yield savings account and we have to raise interest rates after dependent in hopes that my savings account rate will eventually increase again. Thanks so much for your time. I look forward to hearing your response but I thanks so much for your kind words and very thoughtful question. Anna in this podcast. I'm going to answer it by explaining what a CD or certificate of deposit is and how to use one wisely. You'll get an overview of the different types of CDs and learned the best places to find high yield CDs. If they're right for you so look I cover. What is a CD? And it's a financial product offered by many different types of financial institutions including banks credit unions investment firms and insurance companies. It's really different from a savings. Were money market deposit account because you give access to your money for a period or a term so in exchange for agreeing not to touch your money during CDs term you typically get more interest than you would with other types of deposit accounts a CD gives you a guaranteed return. That's the upside. And you get that return no matter what happens to the economy or in the financial markets and there are two ways to measure the interest that you get for a CD one as AP Y and there's a PR SO AP y stands for annual percentage yield. This is the rate that you receive if all the interests that you earn on the CD gets added back to your balance which is called compounding so in other words AP wise the rates. You get if you never withdraw interest from a CD APR which stands for annual percentage rate. That's the rate of interest that you earn without taking into account the effects of compounding in a year. So it's the rate that you get if you did withdraw every penny of interest and you didn't have any compound growth in the account and if you see a CD rate that doesn't say if it's APR A. P. Y. You should assume that it's the AP are now if you purchase a CD that comes with FDIC insurance that stands for Federal Deposit Insurance Corporation. That comes from banks typically or in see you a which stands for National Credit Union Administration. Insurance that comes from credit unions. Obviously if you buy a product that gets either type of coverage you covered for up to two hundred fifty thousand dollars if the institution fails for just about any reason and that two fifty includes not only your principle but your interest in the account and some institutions that are not bank such as insurance companies will offer CDs with FDIC insurance. You don't have to go to a bank or credit union to get a CD that comes with insurance but there are some CD's out there that don't come with insurance so be sure to check the minimum amount required to open a CD is generally five hundred dollars but it could be much higher depending on the institution and the type of CD that you buy and you can put an unlimited amount of money into a CD but to be safe. What I recommend is that you always stay under the FDIC or the NC. You a limit that I spoke about the two hundred fifty thousand dollars and that limit is per account holder per institution. So if you've got more than two hundred fifty thousand dollars you might want to spread it out at different institutions. So let's talk about what the downsides are of getting a CD that you know. The upside. Is I mentioned is a guaranteed return? The downside is that your money is locked up for a specific term that might range from a few months to maybe five years. So you get to choose the term when you're purchasing the CD and when that term ends you get back you're principle plus the accumulated interest? Cd's with longer terms generally yield the highest interest rates. However if you need the money and you need to withdraw money from a CD before it expires and that expiration date is known as the maturity date in that case you typically must pay a penalty and the penalty amount is typically calculated as an amount of interest depending on the terms so for example a one year CD might charge the equivalent of three months worth of interest if you dip into it so it's crucial to be sure that you will not need to withdraw any amount of money before the maturity date when you're buying a CD. So I mentioned that there are different types of CDs. There are some with a fixed term and interest rate. That's called a traditional CD in it's the most common type but depending on where you buy cd you may see some other types as well so let me run through a few of these that you know you may or may not see at the institution that you're using one is called variable. Cd's these pay interest rate based on an index such as the treasury bill rate or the prime rate there are zero coupon. Cd's these pay interest only at the end of the term. And they don't allow the option to withdraw interest as you go so if you had a five year cd you would have to wait until the end of those five years to get any interest. There are add on CDs which allow you to make additional deposits to either a fixed or a variable rate CD. There are callable CDs. These give the bank the right to call or buyback CD after an initial period and before the end of the terms. You would get your money back. There are liquid or no penalty. Cd's these allow you to withdraw a portion of your money without paying a penalty. That's a good option. If you're not really sure if you might need the money or not of course it's GonNa come with a lower interest rate. In most cases there are bump up CDs. These gave you a fixed interest rate with the option to increase the rate one time during the term of the CD to take advantage of any rising interest rates. There are step up or step down CDs. These give you a fixed? Interest rate for a set period and then automatically increase or decrease to a predetermined rate and lastly jumbo CDs. These require a deposit of at least one hundred thousand dollars and typically offer a higher rate of interest before we go on. I want to tell you about a quick and fund. Way that you can help. Keep the money girl. Podcast going these days. Many of us are doing a lot more online shopping than we used to. But did you know that when you shop on Amazon you can also support the show. And the entire quick and dirty tips network. All you need to do is go to quick and dirty tips dot com slash Amazon. You'll find a link that can take you right to Amazon with a little tracking code. Attach that tells Amazon. 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Internet Bank of Indiana has a five-year CD paying one point seven seven percent AP Y. And Ally Bank has a one year CD that pays one point three five percent. Ap Y so going from a one year CD Up to a five year CDs going to get you a little more money if you put one hundred thousand dollars in this one year CD and you did not withdraw any interest. Along the way at the end of the year you would have a hundred and thirty five dollars extra at the end of the term. Now if you want to figure out returns on CDs with longer terms than one year it gets a little bit more more complicated in bank rate has a CD calculator. That's pretty handy. If you want to check it out just like with high yield savings accounts you can find the highest paying CDs at online banks credit unions and investment firms. They typically have lower overhead which means they get to pass the savings along to customers in the form of higher interest rates. But I will say that. Local community banks and credit unions can offer very competitive CD rates when they're trying to attract more deposits. So you really need to shop around to find the best rate now. Let's talk about something called. Cd Ladder Ring. This is a common strategy to maximize earnings by using multiple CDs. Lateran just like you know crawling up a ladder you buy CDs with different maturity dates an annual yields each one represents a rung on a CD quote Unquote Ladder. That goes from shorter terms of two longer terms. So imagine that you bought a hundred thousand dollar traditional five-year CD. Paying one point. Seven five percent now. Think about how bummed out you'd be if you put all that money into a five year CD you locked it up and in interest rates went up. They went up to two point seven five percent. So you're missing out on a whole percentage point on your money if that happened. Let's say the following year you'd be missing out on earning more interest because you locked up your money at the lower rate at one point seven five percent for five years and you can't make a withdrawal without paying a penalty lateran. You might choose to buy five CDs with that hundred thousand dollars instead of just one for instance you could buy a twenty thousand dollar one year. Cd A twenty thousand dollar two years CD. Twenty thousand dollar three years CD and so on up to a five year CD after one year when the very first CD reaches maturity you could use all or a portion of the money to purchase another five-year CD so as your shortest CD matures. You can use that money to buy a longer term. Cd that presumably has a higher interest rate so this technique of lathering protects you against missing out on higher returns if interest rates do rise. You're going to get more money and get greater flexibility at the same time as each. Cd matures you've got the option to renew it at the current rate or to use your money for something completely different so you can use a CD ladder calculator to see how you might benefit from using this strategy and in the notes for this show again there in the money girl section at and dirty tips dot com. I'll put a link to a really good. Cd ladder calculator all right now. When should you buy a CD? Now that you know a little bit more about CDs. Let's go back to Anna's question about whether she should buy one. I do not recommend putting any amount of your emergency fund in a CD. Why well it's going to cost you if you need to make a withdrawal now. Let's say you've got more cash on hand than you need if that's the case you've got plenty of money for your Emergency Fund and you've got even an excess of cash in that case buying one or more CDs may make a lot of sense. I you've gotTA set your target Emergency Fund amount in. I'm going to recommend the equivalent of three or six months worth of your living expenses. But how much you need might depend on your work and your family situation for instance. If you're the only breadwinner in a very large family you might need to save twelve months of living expenses instead of three or six months. So if Anna has more than a healthy amount of savings for her situation putting the excess in a short term CD might be a good option. She could earmark it for something specific such as a vacation or that house that she plans to buy and what happened after the CD maturity date. I recommend that. Anna make accumulating down payment a separate goal from building and maintaining her emergency fund. So if you're in a position with plenty of cash and you're ready to buy a CD. You need to compare rates too high yield savings accounts and money market deposit accounts to really understand what you're going to gain from buying a CD. In some cases you might find that the rates are very close or even lower than some savings products. In that case you know buying the CD doesn't make sense. You'RE GONNA WANNA stick to a high yield savings account so you don't sacrifice any liquidity if you're going to get the exact same return on a CD. And let's say a money market deposit account. You don't WanNa lock your money. You'd rather have it in the deposit account so that you can get to it. Twenty four seven and use it if you need it so remember. The point of having an emergency fund is to have the ability to tap it the moment that you need it and that may not be the case of the money is in a CD. Balancing risk and reward is something that savers and investors must manage. I mean it's something we're always concerned about. Especially when interest rates are at record lows like they are now CDs. Do not offer much return on your money but they do give you a guaranteed return so to sum up by a CD. Only when you have fully funded your emergency fund and you still have a large amount of cash that you WANNA keep safe. You can use one or more CDs if you can earn more interest on those CD's than you would with a savings were money market deposit account. And this could be the situation for you if you're retired or you're nearing retirement or you've got a specific goal that you want to reach after a CD matures such as buying a home starting a business or making any other large purchase and I hope that gives you some direction. And thanks so much again for your voicemail. If you have money question or an idea for a future show topic you can call it in just like Anna did. I'd love to hear it. The number to leave your message is three zero. Two three six four zero three zero eight or you can email me. I'd love to get your email as well. You can do that by visiting my contact page. Laura DE ADAMS DOT COM. That's all for now. I'll talk to you next week until then to living a richer life money girl is produced by the Audio Wizard Steve. Ricky Berg with editorial support from Karen Hertzberg. If you've been enjoying the podcast take a moment to rate and review it on apple podcasts. Or wherever you get your podcasts you might also like backlist episodes and show notes that are always available at quick and dirty tips dot com.