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When shopping for a certificate of deposit (CD), you might run into CD terms that range from a few months to several years. So, which option is best? It depends.
Choosing between a short-term CD and a long-term CD comes down to your goals and when you need to access your savings. Here, we explore the pros and cons of long-term and short-term CDs and how to choose the right one.
What Is a Long-Term CD?
Long-term CDs generally refer to CDs with terms that last three years or longer. Typically, long-term CDs provide a higher annual percentage yield (APY) than short-term ones. The catch is that long-term CDs tie up your money for an extended period, and taking money out early can result in early withdrawal fees.
Another risk of long-term CDs is the possibility that interest rates across the market could increase while your money is locked in the CD. In this scenario, putting all of your eggs in one long-term CD basket could cause you to miss out on earning better yields with other accounts.
Pros of Long-Term CDs
Thinking about opening a long-term CD? Here are some benefits:
- High returns: Long-term CDs typically offer a higher yield than traditional savings accounts, money market accounts and short-term CDs.
- Security: When you open CDs at institutions insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA), deposits are insured up to $250,000 per depositor, per account ownership category.
- Wide availability: You can get long-term CDs from many different types of financial institutions, including brick-and-mortar banks, online banks and credit unions.
Cons of Long-Term CDs
Below are the drawbacks of long-term CDs:
- Early withdrawal penalties: If you end up needing to take money out of your long-term CD before the term is over, you will likely get hit with early withdrawal penalty fees.
- Deposit limitations: Minimum deposit requirements to open a CD can vary. In some cases, there's no minimum deposit necessary to open a CD account, while other accounts may require a deposit of $1,000 or more.
- Interest risks: There's a possibility that yields on savings accounts could increase before your CD matures, and you won't be able to take advantage of those rate hikes if you're stuck in a long CD term.
What Is a Short-Term CD?
Short-term CDs are CDs with terms that last three months to a year or slightly longer. Choosing a short-term CD means your money will only be locked away temporarily, and this type of CD can make sense to deposit cash you need for near-term goals.
Typically, short-term CDs offer a lower return than long-term CDs, but there can be exceptions to the rule. For example, banks may offer promotional rates on shorter-term CDs as an incentive to encourage new or existing customers to open CD accounts. Like other CDs, short-term CDs may have early withdrawal fees if you withdraw money before the CD matures.
Pros of Short-Term CDs
Below are the pros of short-term CDs:
- Better returns for short-term savings: Short-term CDs may offer a higher yield than traditional savings accounts or money market accounts.
- Short maturity timelines: Short-term CDs can mature in less than a year, which gives you access to your initial deposit and interest earnings faster than a long-term CD.
- Deposit insurance: Like long-term CDs, short-term CDs are often protected by deposit insurance, which insures up to $250,000 per depositor and per account ownership category at each financial institution.
- Wide availability: You can find short-term CDs at many different types of financial institutions, including traditional banks, online banks and credit unions.
Cons of Short-Term CDs
Below are some drawbacks of short-term CDs:
- Lower APYs: Short-term CDs may offer lower APYs than longer-term CDs.
- Early withdrawal penalties: If you have to withdraw money from a short-term CD before the CD matures, you'll have to pay an early withdrawal penalty.
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How to Choose the Right CD Term for You
Short-term CDs are best when you're saving for near-term goals, and long-term CDs are better for long-term goals. Say you got a new job and you have some cash saved to relocate in three months. A short-term CD could be a place to park that money until it's time to make the move.
A long-term CD could be the better choice for savings you don't need until a date further in the future—like cash saved to put down on a house five years from now. Aside from the long-term CD possibly offering a higher yield, the threat of being charged penalty fees for making early withdrawals from a long-term CD could forcefully ensure you don't dip into the cash.
Also, consider that you don't necessarily have to choose one option. Setting up a CD ladder could help you maximize the interest and advantages of both short- and long-term CDs. With a CD ladder, you break up the savings you have and open different CDs, which make up the "rungs" of your CD ladder.
For example, if you have $5,000, you could put $1,000 into five different CDs that mature in three months, six months, 12 months, 18 months and 24 months. Then when each CD matures, you can roll them over into new CDs or withdraw your cash.
Alternatives to CDs
CDs are just one type of account that can help you earn interest on savings. Below are alternatives to CDs:
- High-yield savings accounts: High-yield savings accounts earn a higher yield than regular savings accounts and allow you to make regular deposits and withdrawals without worrying about an early withdrawal fee. These savings accounts may have a low minimum deposit requirement, and you may even be able to open an account with $0.
- Money market accounts: Money market accounts may also provide higher interest rates than savings accounts, and they may offer debit cards and checkbooks you can use to make ATM withdrawals or payments.
- Bonds: Bonds can provide investors with a regular source of income by paying a set amount of interest until the bond matures. While bonds are generally considered safe, investing in certain bonds can come with a level of risk since bonds can default if issuers can't make interest payments. Comparing the credit risk for different bond types and understanding how bonds work can help you decide the best ones to invest in based on your risk tolerance.
The Bottom Line
When deciding between a short-term and long-term CD, consider your goals. For money you need to use in the near future, short-term CDs are likely the better choice. Long-term CDs could be a good alternative for cash you don't plan to touch for many years, but be sure to compare rates because the longest CD terms aren't always the ones that offer the best APY. If you have unclear goals for your savings, you could open several CDs. Putting your money into CDs with different terms can help you take advantage of the perks both CD types have to offer.