5 Mistakes to Avoid With a CD

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A certificate of deposit, or CD, is a wise choice when you're looking for a fixed rate of return on your savings—especially when interest rates are comparatively high. In exchange for agreeing not to withdraw the money in your account for a certain period of time, it will earn more interest than it would in a traditional savings account.

But CDs require careful planning to avoid paying early withdrawal penalties or missing out on higher interest rates elsewhere. Here are five mistakes to avoid when adding CDs to your savings plan.

1. Choosing a CD Without Comparison Shopping

Rates for similar-term CDs vary from one bank to another. If you've chosen a one-year CD, for example, compare rates not just among banks, but also among types of financial institutions: banks, credit unions and online-only providers. Credit unions, for example, often offer higher CD rates than traditional banks for the same-term CD, according to data from the National Credit Union Administration.

It may be easy to open a CD at the bank you already use for your checking and savings accounts, but doing so could mean you lose out on higher yields.

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2. Allowing for Automatic Renewal Without Comparing Rates

Shopping around is important not only when you first shop for a CD, but also when the CD matures, or when the initial term is up. The CD may automatically renew, which means it will roll over into a new CD, likely with the same term as before. But you usually have a grace period—typically of seven to 10 days—when you can choose whether to renew the CD or withdraw your money.

If you'd like to renew the CD and keep your savings locked away for longer, check the interest rate your bank has offered. See if the bank has any promotional rates you can ask for. If you see a better rate at another institution, you can ask the bank to match it or withdraw the money and deposit it elsewhere.

3. Not Checking Potential Penalties

If you withdraw money from a CD before its maturity date, you'll incur an early withdrawal penalty based on a certain number of days' worth of interest in the account. On a one-year CD, your bank may charge 90 days' worth of interest as an early withdrawal penalty, for instance, and more if the term is longer. That means your early withdrawal penalty could differ from other customers who have the same rate and term, since it's dependent on the balance in your account.

There may be times when you decide to withdraw money from a CD despite the penalty. For example, if you think you can earn more money in a different account, you may deem it worthwhile to pay the penalty. But it's important to be aware of the penalty when you open the account so that you can make an informed choice later.

4. Missing Out on Investing Returns

A CD is a low-risk savings vehicle that guarantees a certain return for your money, which is important when saving for a short-term goal like a down payment. But if you're willing to keep your money saved for longer or take the risk that it could lose value, investing in a diversified mix of stocks may earn a higher return over time.

If you can, it may be worth it to put a portion of your savings in a CD as part of a diversified savings strategy, and another portion in a brokerage account to take advantage of higher returns. It's also key to invest as part of your retirement plan through a 401(k) or individual retirement account, which gives your money the chance to grow over a long time horizon.

5. Funneling Money to Savings that Should Pay Off Debt

If you have high-interest debt from payday loans, private student loans or credit cards, you may be better served by paying it off before prioritizing saving in a CD. Think of it this way: A paid-off credit card with a 17% interest rate earns you a 17% return in the first year it's off your personal balance sheet. That's more than you'll find with a CD, or even the stock market.

The ideal scenario may be to pay off debt while saving a portion of your funds in a CD, then adding more as your debt disappears. Most financial decisions are not an either/or, but rather an and/both, where you slowly chip away at multiple goals simultaneously.

The Bottom Line

When considering saving in a CD, you won't encounter the risk your money will lose value if you keep it saved until its maturity date. But there are other risks to think about: whether you'll need the money sooner than planned, you've gotten the best rate possible and you're putting the money to its best use right now. Avoiding CD mistakes helps ensure you're getting the best features of a CD without the potential drawbacks.