Opening Your First CD? 3 Key Questions to Ask Yourself First
Opening a CD could be a savvy financial move. But read on to see what questions you should run through first.
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Because certificate of deposit (CD) rates are pretty attractive these days, a good number of people are looking at opening one before rates start to fall. You may be interested in opening your first CD soon. And that's a move that could work out well for you financially. But before you take that leap, make sure to answer these key questions.
1. Am I sure I don't need the money for something else?
When you open a CD, you commit to keeping your money in the bank for a period of time. If you cash out a CD before it comes due, you could face a costly penalty.
That penalty can differ from one bank to the next. At Capital One, the penalty for cashing out a CD early with a term of one year or less is three months of interest. But either way, penalties can eat into your interest income (or even wipe it out, in some cases), which isn't what you want. So before you open a CD, make sure you can afford to part with the money you're putting in for the full length of the CD term.
For example, it's important to leave yourself with a fully loaded emergency fund -- enough money to cover at least three months' worth of bills. So make sure you're able to leave yourself with that much cash after opening a CD.
Furthermore, it's a good idea to look into the future as best as you can and anticipate upcoming expenses before committing to a CD -- especially one with a longer term. For example, is your significant other on the verge of proposing? If so, you don't want to tie up funds you might need to throw a wedding.
2. Have I researched CD rates?
CD rates can vary from one bank to the next. They can also vary based on the CD term you're looking at. It's important to research rates so you end up with the maximum amount of interest earnings.
That said, you'll also need to keep your personal financial timeline in mind when opening a CD. Your bank may be offering a better rate for a 12-month CD term than for a 6-month CD term. But if your apartment lease is up in 10 months and you're expecting to move, you may want access to your money then. So in that case, accepting a lower rate on a 6-month CD makes sense.
3. Am I better off investing in stocks instead?
You might earn more interest with a CD than with a savings account. But if your goal is to earn the highest return possible on your money, you may want to avoid putting more cash into the bank and instead turn to a brokerage account.
Right now, some CDs are paying 5% or more. But the stock market's average annual return over the past 50 years has been 10%. So let's say you have $5,000 to put away and you open a five-year CD at 4% (keep in mind that longer-term CDs aren't paying as much right now as shorter-term ones due to the potential for near-term interest rate cuts.) In five years, you'll have almost $6,100. But if you were to invest that money at 10% over five years, you'd have a little over $8,000 instead.
If you're saving for a shorter-term goal -- say, to buy a home in five years -- then a CD may be a better bet. But if you're working toward a far-off goal, like retirement, then you may want to invest your money in stocks and other assets that have the potential to offer higher returns.
Opening a CD is something you may be excited about. Just address these points thoroughly first so you don't wind up regretting your decision.
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