So, my wife and I are about to inherit a decent sum of money, and we don’t want it sitting around in a bank account. I’ve been looking into two options: a high-yield savings account and CD contracts. My question is this—when you buy CDs, there are term limits like 3 months, 6 months, 9 months, etc., and they all seem to offer similar rates. It looks like the best way to grow our money might be to put a certain amount into a 3-month CD and get it back with interest. But here’s my confusion—if I buy a 1-year CD at 4.5%, wouldn’t I be better off getting four 3-month CDs and earning a total of 18% over the course of the year? Is that how it works, or am I totally off the mark?
The interest rates are annualized. If you’re looking at monthly rates, just divide the annual rate by 12.
Alva said:
The interest rates are annualized. If you’re looking at monthly rates, just divide the annual rate by 12.
Can you explain that a bit more? I’m new to this stuff, I’m 23, and my wife is 22. We’re just starting to figure out how to invest our money.
@Oaklan
Here’s a simple example:
If you put $10,000 into a 5% 6-month CD, you wouldn’t get $500 at the end of 6 months. You’d get $250 instead. The 5% rate is what you’d get if the CD were for a full 12 months, so it’s annualized.
@Oaklan
The rate you see is an annual percentage rate. For a 6-month CD at 4.5%, you’ll only get 2.25% back by the end of the term, because it’s half a year.
@Oaklan
You’re right that four 3-month CDs would give you 4.5%, the same as a 1-year CD. But remember, with the 3-month CDs, you may get a lower rate if the Fed lowers interest rates. Think of it like leases—locking in a longer-term deal keeps your rate the same.
@Sloane
Thanks, I really appreciate the help! I feel like I’m getting a better grasp on it now.
@Oaklan
For the 3-month CD, you’d earn 1.125% for each 3-month period. To get the full 4.5%, you’d need to renew the CD four times in one year.
Have you thought about just opening a brokerage account instead? If you buy SGOV (short-term government bonds), you’ll get around 5% in dividends. It’s a way to keep your money liquid without locking it in a CD. SGOV pays dividends every month, too. It might be a better option if you don’t need immediate access to the cash.
@Peyton
I’ll definitely look into SGOV. Thanks for suggesting it!
Oaklan said:
@Peyton
I’ll definitely look into SGOV. Thanks for suggesting it!
Just to clarify, what’s your plan for the money? Is it extra cash, or is it part of your emergency savings? I used to do CDs a while ago, and the max I got was around 5.5%. But now, I’m putting my money into the market, which gave me an 18% return last year. Keep in mind, though, the market is for longer-term investing (think 10+ years).
@Peyton
So the expense ratio on SGOV is 0.090%, but what are they doing with those 3-month T-bills to justify that rate?
Interest rates for CDs are always based on an annual yield, even if the term is shorter.
Just remember that interest on CDs is always calculated annually.
CDs are pretty outdated. You’re better off using treasuries or a money market fund.
Here’s a tip: if you decide to go with a CD, make sure it’s non-callable. That way, the bank can’t pay it off early and leave you stuck with less interest than expected.
I’ve done a lot of CDs, but lately, I’ve been disappointed with the brokerage CDs. Some of them got called (paid back early) even though the banks were struggling last year. One thing I recommend is creating a CD ladder—put some money into CDs that mature at different times. This way, you always have some cash available. You can also ask the bank to pay your interest into a high-yield savings account (HYSA), which gives you better cash flow, even though it messes with compounding.
@Kirby
The idea of a CD ladder seems smart, especially if you’re not sure about locking your money in for too long. This can help you stay flexible and ensure that you have predictable cash flow. While it doesn’t maximize compounding, the flexibility is a huge plus if you need access to cash. I’ve used a mix of different methods like robo-advisors and HYSAs to meet my short-term needs, but I think consulting with a financial advisor can really help fine-tune strategies like these based on your unique situation.
Why are you putting money into CDs at your age? There are better options. You could put it in a Schwab money market account, which will give you between 2.49% and 4.63%, and still keep it liquid. Or, put it into an index fund, which could give you more over time if you don’t need the money now. If you’re still set on CDs, you should look into laddering them. From what I know, you get a better return the longer you leave your money in, but you can break it up into different term lengths (3 months, 6 months, etc.) so you have access to part of your money periodically.
You’re actually wrong about how CDs work. Imagine if you could really get 18% guaranteed every year—wouldn’t that be amazing?