A bank CD account can do so much more than just earn interest and shelter your money. When used wisely, a certificate of deposit can save you in a financial pinch, or even fund your future. And no matter what you use your CD account for, employing smart CD savings strategies will get you to your goals that much faster.
We asked personal finance expert J.D. Roth — founder of Get Rich Slowly and More Than Money, and contributor to Entrepreneurmagazine and Time‘s business site — for tips on maximizing your CD saving experience. Here are his top four pointers:
Consider using CDs for emergency funds
“With an emergency fund, there’s often the temptation to access that money for things other than emergencies,” says Roth. “An emergency fund needs to be money that you’re not going to be able to touch as easily.”
That’s why Roth says he considers a certificate of deposit to be the perfect vessel for an emergency fund. “If you put your money in a CD, the penalty for taking it out early is often enough to deter people from withdrawing it,” Roth says. “Anything you can do to make that money difficult to access will help keep you on track.”
Make your CD a “targeted” savings account
“If I have a savings goal — for a house, a car, a child’s education — I can set up a savings account specifically for that goal,” Roth explains. “And a CD works just as well as a savings account.”
Roth comes to this CD strategy with firsthand experience. “One year, I knew I wanted to take a vacation overseas. I knew I wanted to save money for this trip,” Roth recalls. “So I put money into a CD. When it matured, I rolled the money over into another CD. I just kept rolling it over until we took the vacation. It gave me more incentive to save.”
Climb the CD Ladder
A CD ladder is a technique of spreading out your CD deposits over several different accounts over several years. This allows you to take advantage of the best long-term rates available at the time, while still giving you the option to opt for higher interest, should CD rates rise down the line.
“Using a CD ladder is very much like dollar-cost averaging,” Roth explains. “Instead of just buying one CD, you buy four — one that matures in one year, a second that matures in two years, another that matures in three years, and another in four years, for instance. You’re spreading your money around. Every time one matures, you buy another four-year CD. You’re rolling your money over again and again, so you don’t just have your money locked up in one CD.”
Buy CDs in parallel
“With CDs, if you have to get to your money before the account matures, you get that penalty,” Roth explains. But if you spread your money out among several CDs at the same time (or, “in parallel”), you can withdraw your money early from only one account, thereby costing you a smaller penalty.
“Say you have $5,000,” explains Roth. “You can open five different CDs, each for $1,000. So if you need to get to only a part of the money — say, $1,000 — you’ll only have to pay a penalty on $1,000 instead of on $5,000.”
Ally Bank offers several types of CD accounts that make it even easier to follow Roth’s advice. For instance: Like CD laddering, Ally’s Raise Your Rate CD lets you take advantage of CD interest rate increases (unlike CD laddering, you only need to open one CD). Open an Ally Raise Your Rate 2-Year CD and — should CD interest rates rise — you can opt for one rate increase; open an Raise Your Rate 4-Year CD, and you can opt for two rate increases.
Plus, if you’re worried about having to pay penalties for early withdrawal — and are looking for an alternative to buying CDs in parallel — you can take advantage of Ally’s No Penalty CD: It gives you the freedom to withdraw all your money without a penalty, after the first six days following the funding date.
What do you use CD accounts for? What CD strategies do you employ?