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If you’re following rates on certificates of deposit, you probably know that you can get around 5% APY from most major banks and digital accounts — which isn’t a bad deal for a guaranteed investment. Yes, you could put that money into the stock market and hope for a higher return. But given the past few years of market volatility and the current stresses of elections and recessions, it could make sense to choose the guaranteed option.
That’s what we did, after all. Our household — that is to say, myself and the Gentleman of the House — took our money out of the stock market years ago, recognizing that the record highs might not return for some time. With the goal of maximizing compound interest while avoiding market risk, we started putting our cash in 5% APY CDs and 4.5% APY high-yield savings accounts.
I’m not a professional investment advisor, but I have been writing about personal finance for over a decade. I’m also fairly good at math, so I know that the difference between putting $50,000 in a 4.5% APY savings account for five years and locking it into a 5% APY CD for the same amount of time is a little more than $1,500. We’d end the five-year period with $63,814.08 in the CD and $62,309.10 in the savings account, assuming annual compounding — and, of course, assuming the interest rate on our savings account didn’t change.
That’s why we’re keeping two years’ worth of expenses in cash — the risk of breaking the CD and taking the penalty isn’t worth the extra $1,500 we might earn if we were able to go five years without accessing our emergency fund.
At this point you’re probably thinking two things: First, that you might not have two years’ worth of expenses in cash; and second, that there are a handful of 5% APY CDs from reputable banks that currently only require a 10-month commitment.
Does that mean you should invest in a certificate of deposit?
Every CD has a breakeven point
Whether you should invest in a CD comes down to whether you anticipate breaking the CD — and whether you can do enough math to calculate the breakeven point.
First of all, if you don’t have at least six months’ worth of expenses in cash, don’t mess around with CDs. Stick your money in a HYSA and keep building your e-fund.
But let’s say you’ve got enough of an emergency fund to cover your household during a period of lower-than-usual income or higher-than-usual expenses. Let’s also say that you’re up to date on your tax-advantaged retirement savings, including health savings accounts. At that point, you can consider putting your extra cash into one of those 10-month 5% APY CDs, assuming they’re still available — and you probably won’t even need to worry about the breakeven point, since the odds that you’ll spend down your six-month e-fund in the 10 months before your CD matures are extremely small.
That said, I know there are people who are going to put a portion of their emergency fund into a CD under the assumption that they can make it 10 months (or five years) without needing the cash. I also know that some of those people will ask themselves, five months down the road, whether they should break their CD.
If you’re dealing with a for-real emergency, in which the necessity of accessing cash immediately outweighs all other possibilities, obviously you’re going to break the CD and take the penalty. (I’ve broken a CD before, when I was younger and less skilled at anticipating my financial future. It’s not the end of the world.)
But if you’re considering breaking the CD versus some other option, such as taking out a credit card with a 15-month 0% intro APR and covering the expense that way, it’s worth knowing whether you’ll break even on the broken CD.
Dig deeper: High-yield savings account vs. CD: What to know when rates are high
Early withdrawal penalties — and where to find them
Banks are required by the Truth in Savings Act to provide information on the various penalties for CD early withdrawals, although you may have to dig through the fine print to find them. In most cases, you will owe a certain amount of interest back to the bank regardless of how much interest your CD has earned prior to the withdrawal. This means that if you break a CD too early, you’ll end up paying a portion of your initial deposit to the bank.
How much you’ll have to pay depends on the bank, the account and the fine print around interest.
If you take out a Capital One 360 CD at 5.10% APY for 10 months, for example, you’ll owe three months’ interest back to Capital One if you break the CD early.
This means that the breakeven point on this particular CD is three months long. If you can make it more than three months without breaking the CD, you’ll earn money. If you break the CD before three months are up, you’ll lose money.
On the other hand, if you take out a Synchrony Bank CD at 5.25% APY for 9 months, you’ll only owe 90 days of simple interest if you withdraw early.
Simple interest is the opposite of compound interest, and it’s calculated based only on the principal deposit. The math gets a bit more complicated here, and it’s probably easiest for me to tell you to just wait 90 days before breaking the CD, but there is a scenario in which you could come out ahead a little earlier. Synchrony Bank also lets you withdraw the interest from your CD at any time without penalty — which, depending on how much you deposit, could help you cover an unexpected expense without too much extra cost.
Look for early withdrawal details and penalties in your CD’s terms, conditions and disclosures to help you decide whether a particular CD is worth it.
It’s also worth taking the time to consider your financial situation and whether you’re going to need the money before it matures. If you’re at all concerned that you might need to break your CD before the breakeven date, don’t make the deposit. Keep the money in a high-yield savings account and focus on other income-building strategies.
Spending less is always an option, but I prefer strategies and tactics that allow you to improve your skills and earn more money — which, in many cases, outperforms even the best guaranteed return.
Related reading: What is a CD ladder? How to build one — and capture high rates before they drop
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About the writer
Nicole Dieker is a seasoned freelance writer with a focus on personal finance and personal development. Her expertise has been featured in Yahoo Finance, Newsweek, Bankrate, NBC News, Lifehacker, Penny Hoarder, The Simple Dollar, Vox and other top media brands. Nicole also spent five years as a writer and editor for The Billfold, a personal finance blog focused on honest conversations about money.
