Are You Overlooking These 3 Essential Features When Choosing a CD?
KEY POINTS
- Pay attention to how often your CD interest compounds.
- You should also look at the penalties for early withdrawal.
- Noting whether the CD auto-renews can help you avoid losing money.
When you pick a certificate of deposit (CD) to invest in, interest rate is a standout in regards to importance. So is term length. These determine how much you'll be paid and how long you have to keep your money locked up.
But there are other key features to pay attention to as well. If you don't focus on these three factors too, you could end up making the wrong choice.
1. How often the CD compounds
All CDs pay interest -- but they have different ways of paying it.
With some CDs, interest compounds daily. That means that the interest is added onto your principal balance at the end of each day. The next day, you're paid interest on a slightly higher balance because of it.
Other CDs compound less often, such as monthly or even quarterly or annually. If a CD compounds monthly, the interest earned isn't added onto the balance until the end of the month. You miss out on the extra interest that comes from daily compounding.
The less often a CD compounds, the less you make on it. Check out the table below showing the difference between your annual return on investment (ROI) if you invest $5,000 in a 5-year CD paying 3.68% that compounds daily versus one that compounds monthly or annually.
Daily Compounding | Monthly Compounding | Annual Compounding | |
---|---|---|---|
Ending investment balance | $6,010.02 | $6,008.39 | $5,990.25 |
Always check to find out how often your CD compounds. If you're looking for a 5-year CD paying a decent rate that compounds daily, Barclays Online CDs can be a good option. You can also check out The Ascent's guide to the best 5-year CDs to find other picks.
2. What the penalties are for early withdrawal
If you take your money out of your CD early, you're typically penalized.
Ideally, you won't open a CD if you can't commit to keeping your money invested for the term length. But sometimes your plans don't pan out and you have to take money out sooner than expected. Or interest rates rise more than expected and you want the flexibility to withdraw funds early.
It can be a good idea to look for CDs that minimize the penalties you'll owe. If you aren't 100% sure you can keep the funds invested, you can also look into a no-penalty CD. Some banks that offer them include:
3. Whether the CD auto-renews
Some banks automatically roll over your CD at the end of the term unless you tell it otherwise. This could mean, for example, that if you have a 5-year CD mature and you don't act, the bank automatically puts your money into a new 5-year CD at the end of the first five years. This often includes the interest you earned.
Other banks don't automatically roll over your balance. If you choose a CD that doesn't, your CD will stop earning interest when it matures.
You need to know what happens with your CD, so you can take action. You may not want to automatically reinvest the funds with a CD at the same bank if there are better offers out there. The bank's website should tell you if your CD auto-renews. Pay attention to this when you invest.
By focusing on these three features, you can make absolutely certain you get the best CD for your situation.
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Our Research Expert
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