Certificates of Deposit (CDs) are the final account in the Phippen Tax & Financial Services Accounts You Want because CDs allow you to save for mid-term goals in a safe way that still allows you to gain interest. As a reminder about why you want a CD:
CDs are a safe place to invest money for reliable returns, particularly if you are waiting until a specific future date to make a large purchase. Goals like acquiring an investment property are ideal for a CD. If you do not need the money immediately but do not want to save it for regular retirement age, CDs provide a mid-term option. In short, CDs are a great place to set aside money for mid-term goals where you need guaranteed returns.
The In-Between Account
Most accounts previously discussed focus either on protecting you from immediate emergencies or investing for retirement, without money dedicated to the years in the middle. The brokerage account discussed last week can cover the later part of these in-between years, particularly if you retire early or reduce your workload so you begin withdrawing from your brokerage account before traditional retirement age. However, brokerage accounts remain remarkable because of the growth they experience, so withdrawing the money earlier in those in-between years limits their effectiveness.
CDs are the solution for the early in-between years. If you feel comfortable locking some money away for a specific time interval between one month and ten years, CDs can offer a safe place to store your money with guaranteed returns over the time period chosen.
When to Use a CD
While money management tends to focus on the immediate and the long-term (retirement), the years in the middle are just as important. You probably have a lot of life goals to hit between your 20s and 60s, and CDs can facilitate your financial planning. If you plan to retire from the military in five years and want to buy a beachfront home at that time, a CD could be the perfect place to invest your money to save for that home. If you are working towards buying an investment property, but you do not plan to buy it until you return from a year living in Laos, a year-long CD is a great investment vehicle.
Real estate is not the only mid-term investment for CDs: children, and all the expenses that go with them, are worth saving for even before they are born. If you and your partner want to have children in three years, leave yourself an investment present to use towards whatever expenses you underestimated when the children arrive. While 529 plans are the gold standard for college savings, CDs can also supplement, particularly to provide a safe investment over a shorter period of time if you start saving for the costs of college later in your child’s life. As the only grandchild of generous grandparents (including a financially savvy grandmother who managed the finances for a state business back in the 1940s and 1950s when women were only supposed to be nurses and teachers), I benefited from a CD when my grandparents invested in a CD with six-month investment periods so I could use the interest from the account to pay for books each semester of college, then lock the money in for another six months.
You can probably find creative examples in your life where CDs may be an ideal investment tool. While vacations are usually more suited for high-yield savings accounts (HYSAs), if you have a wedding invite for more than a year from now and already have a good lump sum ready for travel, a CD may be right for you. To assess whether a CD is right for your mid-range spending goal, two details should be true:
You already have a lump sum ready to invest and want to grow it, safely.
Your spending goal is at least three months in the future. (Six months, a year, or more is even better.)
Why are CDs Safe?
CDs are insured by the Federal Deposit Insurance Corporation (FDIC). This means that the bank holding the CD is an FDIC-insured bank, so if the bank fails, the FDIC will step in to help you recover your funds. The FDIC will insure up to $250,000 per depositor, per insured bank, so you should not exceed $250k with any one bank to realize the full safety net.
In stark opposition to a brokerage account, CDs also avoid market fluctuations since they are lump-sum investments provided to a financial institution for a designated period of time. At the end of the investment period, you can count on the money you invested being there with the interest initially quoted.
How CDs Work
When you open a CD, you choose how long you want to invest the money. Whatever period of time you choose, you should absolutely not plan to withdraw your money before the CD investment period is complete. There are fees to remove money early, so if you worry whether you will need the money in one year or 18 months, choose one year to avoid risk.
The longer investment period you choose, the higher interest rate you will receive. If you are willing to lock up your money for five years without touching it, you will receive a better rate than a person locking up their money for only one year.
The interest rate you lock in will hold for the entire length of your chosen investment period. If your investment period for a three-year CD is a 5% annual percentage yield (APY), you can count on receiving 5% APY on your investment. However, if you choose an investment period of one year and then decide to reinvest for another two years, the interest rate may be different. Sometimes this works in your favor: If interest rates were extremely low when you first invested, they may be higher on a two-year CD when you reinvest than they were on a three-year CD a year ago. However, interest rates can also decline, making your investment experience less growth than if you had locked up the money for a three-year investment period initially.
CDs vs Happiness Spending Goal HYSAs
If CDs seem closely related to saving for happiness spending goals in HYSAs, you are correct: The only difference is the time frame for the goal or experience. If you might need to use the money in less than three months, it belongs in a HYSA. In reality, the interest rates are not extremely different between a HYSA and a three-month CD, so the threshold is more practically at six months.
Some happiness spending goals are set dates in the future: You can predict when your parents’ 50th anniversary trip to Bermuda will be years in advance. This makes it a potential candidate for a CD. The unpredictable trip that you may take in a month or a year is a better candidate for a HYSA.
The other important criteria for a CD is that you already need to have a lump sum ready to invest. If you are starting from zero and planning on contributing generous monthly amounts to save for a trip, you need a HYSA. However, if you received an end-of-year bonus and figured that is the perfect money to start investing to fund the down payment on an investment property in three years, choose a CD.
Why CDs Would Not Make This List a Year Ago
Interest rates were extremely low a year ago (and even lower the year before), making the rate of return on a CD almost nothing. The interest rates were barely higher than HYSAs, which were also barely above zero. I actually rolled my CD into a Fundrise account (more on Fundrise will be in “Part 4, Accounts to Have for Fun”) when the period of investment ended back in 2020 since it made more sense to move it somewhere that offered more returns.
Staying on top of the current interest rates may seem tedious, but there are clues to follow: If it is a good time to buy a house, it is probably a bad time to invest in a CD. Within a year of removing money from a CD, Patrick and I also bought a home to take advantage of a 2.75% mortgage rate. If it is a bad time to buy a house, which it increasingly is right now, it is probably a good time to open a CD.
If interest rates are low across the board, investing in a HYSA or CD makes so little difference that it may not be worth opening the CD. It also may be worth waiting to see if interest rates rise, making it better to invest in a CD in six months. If you do not need the money for a longer period of time, there may be other investment opportunities as well. (For example, Fundrise is a five-year investment commitment.) If interest rates are low, do not choose a CD, but monitor the situation to identify when a CD may be beneficial again.
Since interest rates are rising again, CDs are back on the list of accounts you want, for the right spending goal. If you have a lump sum of money and a mid-term need for future spending, CDs offer the balance of a safe investment that still offers returns on your money.
About the Financial Accounts Series: The Financial Accounts Series is a four-part series discussing financial accounts that can improve the health of your finances. The Phippen Tax & Financial Services team will provide a deep dive on each of the accounts listed in Part 3, Accounts You Want, before releasing Part 4, “Accounts to Have for Fun.” If you missed Part 1, Accounts You Need First and Part 2, Accounts You Need Next start there! If you would like to seek additional guidance about your personal finances or the specific organization and composition of your financial accounts, please contact Patrick Phippen or complete a new client form if you have not worked with Patrick in the past.
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