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- I trust fixed CDs, which have an API and maturity set when I put my money in them.
- However, variable-rate CDs and no-penalty CDs offer flexibility to consider.
- Another option that allows me to switch part way to a higher APY is bump up CDs.
At the beginning of 2023 I decided that I wanted to reduce the risk in my finance portfolio as much as possible. I was eager to increase my net worth in a steady and predictable manner. That’s why I decided to move money from investments and high-yield savings accounts to CDs.
So far this year CD rates have been rising and I’ve been able to secure CDs with 4.75% to 5.5% APY.
But when I started doing more research, I learned that there are four main types of CDs. To make sure I’m choosing the right CDs for my financial goals, we sat down with certified financial planner Christopher Manske to explain what makes each type of CD different and the benefits of each.
Before choosing a CD, understand the current liquidity
Manske recommends first understanding your liquidity needs before exploring different types of CDs and choosing which ones to go with.
“For example, if you have a short-term need, say you plan to buy an expensive item in the next three months, you can look at CDs that mature at that time so that you can get your money back to buy your purchase.” he said.
However, if you have enough money to pay off the item in three months, or the amount of money is not an issue for you, then you can go with a CD with a longer maturity date. Once you get a pulse on that, Manske says you can decide what type of CD is best for you.
1. Fixed-rate CDs
The type of CDs I rely on are fixed rate CDs. As Manske explained, those are CDs with a predetermined interest rate for a certain length of time. For example, a CD may offer a 5% APY with a 12-month maturity.
“A common mistake people make with fixed CDs is thinking that they’ll earn the interest stated over the length of the CD, but that’s not always the case,” he said. “CD interest rates are for 12 months.”
For example, Manske said, if you take out a CD with a 3% API for six months and deposit $100, you will not have $103 at maturity. You will have $101.49.
However, Manske said that such a CD is very good for someone with a predictable value.
“With fixed CDs, people can know exactly how much money they’re going to make,” he said. “There is no difference or difference.”
2. Variable-rate CD
Since I’m mostly risk-averse with my CDs, one I’ve never tried is a variable-rate CD. Manske said these are CDs tied to an index like the S&P 500, and as the index moves, the interest rate the CD pays changes. The interest rate can go up and down throughout the maturity of the CD.
“It’s not as simple as looking at the index at 10% and thinking your CD is doing 10% more,” he said. “It’s proportional and based on percentages.”
Manske shared that people with less risk appetite and who are comfortable with the interest rate on their CDs going up or down may decide to use variable-rate CDs.
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3. Compressed CD
If you want a little more flexibility with your CD terms, Manske said, you might consider choosing a CD that allows you to increase the interest rate once before maturity. However, compressed CDs with longer terms may allow for multiple price adjustments.
For example, if you have a one-year CD with a 5% increase option, Manske says you can pay attention to the CD’s rates and choose to upgrade it if the rate goes up.
But not many people buy CDs because they need to increase the CD rates and then go through an administrative process with the bank to convert the CD to a higher rate. .
4. CD without penalty
For someone who can’t lock up their money for a certain amount of time and doesn’t want to face penalties if they have to withdraw their money before maturity, Manske suggests looking at liquid CDs, also known as CDs. As no penalty CDs.
“Liquid CDs don’t pay you as high an interest rate as other CDs, but you can withdraw your liquid at any time,” he said. “Usually within two days of money going into the CD.”
You can withdraw your money from a CD without any fees or penalties.
“This CD is usually an option for someone who doesn’t have a lot of capital or is currently in a tight spot,” he said. “Instead of keeping the money in a checking account, you can get a little more in a liquid CD.”
After learning about these CD options and thinking about my liquidity for the next year, I decided to stick primarily with fixed CDs and try one or two variable rate CDs to see how my money would perform.