Young Investor? Avoid These Mistakes When Starting Your First CDs

Many certificates of deposit (CDs) are currently paying high rates, which is likely enticing for many young investors looking for a safe place to put some of their money. In addition to their currently high annual percentage yields (APYs), CDs have many benefits, including being FDIC-insured, which makes them a very safe place to invest money.

However, investors can make some mistakes with CDs, especially if it's their first CD and they don't understand how they work. Here are three common mistakes and how to avoid them.

Mistake 1: Not shopping around for the best rate

There are many CD options available, and many young investors may not know that the CD rates that banks pay can vary dramatically.

The national average APY for a 1-year CD is just 1.76%. That might not seem like a bad deal, until you compare it with some of the highest-yield CDs that pay above 5%. As with any investment, the larger the percentage you earn, the more money you make.

For example, if you invested $3,000 in a 1-year CD with a 1.76% APY, you'd earn $52.80 in interest by the end of the term. But if you chose a 5% APY CD, you'd earn $150 -- nearly three times as much!

How to avoid it: Spending just a few minutes comparing CD rates online will help you avoid getting stuck with a CD with a low APY. You can compare high-yield CDs on The Ascent's list of best CD rates. The best CDs offer a variety of terms and minimum deposits that will fit many investors' criteria.

Mistake 2: Paying an early withdrawal fee

When you put your money into a CD, you agree to leave it there for a set time. This is referred to as the term of the CD, and it can range from a few months to several years.

Choosing the right CD term is important because you'll be charged a fee if you withdraw your money early. Most CDs with terms longer than two years charge an early withdrawal penalty of 180 days of simple interest on the money you withdraw. CD terms that are two years or less usually charge 90 days of simple interest.

Let's assume you invested $3,000 in a 2-year CD that pays 5% APY. If you took the money out after just 12 months, you'd be charged an early withdrawal fee of $230.69, effectively lowering your APY to just 2.56%.

How to avoid it: Think about how long you're willing to part with your money for, and don't invest money that should be in your emergency savings. If you're investing in your first CD, choosing a shorter term may be a good idea so you can get the feel of having your money tied up for a while.

Mistake 3: Ignoring the impact of inflation

One thing young investors may overlook is the effect that inflation has on their money. While inflation always impacts people's money, its acceleration in the past few years means that investors should pay even more attention to how much money their investments earn.

For example, the current rate of inflation is 3.48%. Let's assume the inflation rate remained steady over the next year, and you invested in a 1-year CD that paid you 3.5%. In this scenario, the interest you earn over that year in the CD is only barely helping your money keep up with inflation.

How to avoid it: If your goal is to earn more money than you have right now rather than just maintain what you have, you should choose a CD APY rate as far above the inflation rate as you can get. Thankfully, that's relatively easy, as many CD rates are at 5% or higher right now.

CDs can be an excellent place for young investors to put their money, but it's essential to understand their limitations and drawbacks. Only put money into a CD that you won't need to use during the term, and make sure you shop around to find the best available CD rate.