If you have savings in the bank that you aren't going to need anytime soon but that you don't want to put at risk by investing, certificate of deposit, or CD, accounts could be a great option. Yields on CDs have increased dramatically over the past couple of years, and while yields on savings accounts have done the same, CDs allow you to lock in a specific yield for a period of time.
But what is the right CD maturity term for you? Here's a quick comparison of the pros and cons of two of the most popular CD terms, 1-year and 5-year, as well as a discussion of an alternative strategy that could be better than choosing a specific maturity term.
Reasons to use a 1-year CD
The most obvious advantage of using a 1-year CD instead of a 5-year CD is that your money won't be locked up for quite as long. If you're pretty sure you won't need your money for the next year but may need it to cover expenses within the next five years, a 1-year CD is probably the better choice for you.
In addition, while this isn't typically the case, in the current higher-rate environment, shorter-term CDs actually have higher yields than longer-term CDs do in most cases. As an example, one bank on our top CDs list currently has a 5.50% APY on 1-year CDs, while the same bank's 5-year APY is 4.50%.
It's also important to note that if you do need your money before your CD matures, you'll likely have to pay a penalty, but penalties can be less severe on shorter-term CDs. Early withdrawal penalties for CDs are usually a certain number of months' worth of interest, and many banks impose larger penalties for early withdrawals from long-term CDs.
Benefits of a 5-year CD
As mentioned, 5-year CD rates are generally lower than 1-year yields in the current interest rate environment. But even though this is the case, a 5-year CD could still be more appealing to some people.
For one thing, if you plan to rely on your CD for steady income, it could make sense to lock in a 5-year CD APY, so you'll know exactly what your income will be for the next five years. After all, while you can get a better APYnowwith a 1-year CD, there's absolutely no guarantee that you'll be able to renew it at a similar rate when it matures in a year. I'll spare you an economics lesson, but the reality is that 5-year CD rates are generally lower because interest rates are widely expected to get lower within the next few years.
Which is right for you?
The better CD maturity term for you depends on a few factors, particularly the likelihood of needing the money before the CD matures, whether you rely on your CDs for income, and your financial goals and risk tolerance.
An alternative to consider is a CD ladder, which involves dividing your money across CDs of different maturity lengths. For example, if you have $10,000 to put into CDs, you might use $2,000 to open a 1-year CD, $2,000 to open a 2-year CD, etc. The idea is that some of your money will be locked into stable long-term CD rates, while some will also mature and become available once a year. And if you don't need the money as the CDs in your ladder mature, you can use them to fund new long-term CDs and keep the ladder going.
The bottom line is that both 1-year and 5-year CDs have their pros and cons, but it's a mistake to think of it as an either-or decision. While one or the other could be the clear choice in certain situations, the best answer for you might be a combination of CDs with different maturity lengths.
This article was written by Matthew Frankel, CFP® fromThe Motley Fooland was legally licensed through theDiveMarketplaceby Industry Dive. Please direct all licensing questions tolegal@industrydive.com.
The opinions expressed within this article is that of Matthew Frankel and not that of M&T Bank, nor does M&T Bank endorse the opinions.
This article is not intended to provide tax, legal, accounting, financial, or other professional advice. Always consult a qualified professional about your personal situation.
