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Here's the Single Best Strategy for Investing in CDs - The Motley Fool

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There's a reason putting money into a CD versus a savings account can be beneficial. CDs require a commitment that you'll keep your money in the bank for a specific period of time. As such, CD rates tend to be higher than savings account rates.

Also, when you keep money in a savings account, the interest rate there can change with market conditions. When you put money into a CD, the rate you lock in is the rate you're guaranteed for your CD's entire term.

So, let's say you open a 2-year CD paying 4.5% interest. Let's say you also keep some money in a regular savings account paying 4%. A year from now, your savings account might only be paying 2%, and new 2-year CDs might only be paying 2.25%. But because you locked in a CD for a duration of two years, you're guaranteed 4.5% interest for another 12 months as long as you leave your money where it is.

That said, if you're going to put money into CDs, you'll want to do two things:

  1. Make sure your bank is FDIC-insured so you're protected from losses in the event of a bank failure.
  2. Ladder your CDs so you have money coming due at various intervals, as doing so could help you avoid early-withdrawal penalties.

It pays to ladder your CDs

Figuring out whether your bank is FDIC-insured is easy. First of all, your bank will usually indicate whether it's FDIC-insured on its website. And if not, you can look up your bank here.

Laddering your CDs requires a bit more time and strategy. But it's really not a difficult thing to do.

With a CD ladder, all you're doing is splitting your money into different CDs with different maturity dates. That way, you have money coming due at varying intervals.

Why is this important? You might think you're okay to tie up, say, $10,000 in CDs because you don't need that money for something specific. But what if a major home repair comes up that depletes your emergency fund and still leaves you in need of cash?

In that case, if you have to wait another year for your $10,000 to free up, you might end up resorting to debt. But if a portion of that money is about to become available, you may not land in such a jam.

To this end, what you may want to do is take the total amount of money you're looking to put into a CD and split it into four. And then, open CDs of varying terms.

If you have $10,000, that might go as follows:

  • You open a $2,500 CD with a six-month term
  • You open a second $2,500 CD with a nine-month term
  • You open a third $2,500 CD with a 12-month term
  • You open a fourth $2,500 CD with an 18-month term

This way, you have CDs coming due at different times, giving you an opportunity to access your money.

And you may not even need that money for an emergency. You may simply want some cash to join friends on an exciting trip, or you may decide you'd like to invest in conjunction with certain market conditions. If your money isn't all tied up, those options may be available to you.

Do your best to avoid a penalty

Once you open a CD, it is possible to access your money prior to its maturity date. However, doing so usually means facing a costly penalty, the amount of which will depend on your bank and its policies.

At Capital One, for example, you'll lose three months of interest as a penalty if you cash out a CD with a term of 12 months or less prior to maturity. For any CD with a term longer than 12 months, that penalty is six months of interest.

That interest income is money you really don't want to lose. But if you're careful in how you set up your CD ladder, you can certainly lower your risk.

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