CDs are similar to high-yield savings accounts , except in return for locking your money away for a certain period, you are usually rewarded with a slightly higher interest rate, especially if you choose a CD with a longer term.
Personally, I don't think CDs offer enough of a return to offset the amount of flexibility they take away from me. In fact, there is only one potential scenario in which I can see myself using a CD: saving for education expenses.
CDs occupy an interesting middle ground
Most experts recommend using CDs for short-term savings that you know you won't need to access for at least a year. This could be for things like a down payment , property taxes , or college tuition.
Personally, I don't see many reasons to use CDs because they occupy a weird middle ground between high-yield savings accounts and investments.
If I think that I'll need to use my money in the next one to three years, I'll use a high-yield savings account to store those funds. And if I know I won't need to use the money for five to 10 years or more, I will invest it in a blend of stock and bond index funds , which I am confident will provide much better returns than any bank account over a long period of time.
CDs are only useful for the gray area between those two time horizons. If I need to use money three to five years from now, I would consider a CD, and that's because of the rates they offer.
CD rates compared to high-yield savings accounts
Different banks offer different rates on CDs, but I'll use Discover as an example as it usually offers competitive rates. In June 2020, rates were:
- One-year CD: 1.01%
- Three-year CD: 1.15%
- Five-year CD: 1.20%
- 10-year CD: 1.25%
I don't think CDs are particularly useful for any time horizon under three years because, in most cases, you can get the same, if not better, rate with a high-yield savings account. Plus, with a savings account, you can access your money and add to it at any time, penalty-free.
At this point, you might be wondering why anyone would sign up for a one-year CD rather than a high-yield savings account.
The only benefit is you lock in an interest rate. If you locked in a three-year CD with a 1.15% interest rate, and then rates fell and high-yield savings accounts started paying 0.75% in annual interest, you'd still be making 1.15% until your CD expired.
However, this factor can work in reverse as well. If rates rise and high-yield savings accounts start offering 1.50% in annual interest, you'd be stuck with a CD that is underpaying.
The only reason I'd consider using a CD
For me, the only time I could see myself using a CD is for tuition payments it's one of the rare times you know with nearly 100% certainty how you'll need your money in three to five years.
I don't have kids yet, nor have I started saving or investing for my hypothetical kids' college tuition , but college tuition is the only middle ground in which you know with a high degree of certainty that there is a fixed payment due one, two, three, and four years from today (and sometimes multiple payments per year).
My strategy would be to keep the payments due in one and two years in a high-yield savings account, and save for the year-three and year-four payments with a CD.
Of course, you could use CDs for other short-term savings goals, such as down payments, home renovations, automobiles, travel, and more. The reason I choose not to is because plans frequently change. If my travel plans get canceled or I decide to buy a home a year later or sooner, I'd prefer to have that flexibility with my money.
What about a 529 account?
When it comes to tuition and education expenses, a 529 account is a common tax-advantaged solution that many people turn to.
I would certainly consider this option as well for a few reasons:
- It's a tax-advantaged account
- It can offer higher returns than savings accounts and CDs since you can invest in index funds, stocks, and bonds
- Depending on what state you live in, you can lock in a low tuition rate early on
A 529 account comes with many benefits, especially if you plan to save over a long time horizon and plan to take advantage of the tax-free investment growth. However, I would still consider a CD.
For one thing, it's a safer investment than a stock or bond, and if the education expense is coming in less than five years, it may be the less risky choice. And two, if for some reason I no longer needed the money for education expenses (someone drops out, decides not to attend, or earns a scholarship), the money is flexible and can be used for anything else without a cost.
For me, deciding between using a CD and 529 account for future education expenses will depend on my situation at the time that I start saving.
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