Keep Your CD’s Liquid and Still Earn a High Rate of Return

CD Liquid high interest rateMost investors probably don’t have too many high yielding ‘safe’ investments lying around from the high interest rate days.  The 5% CD’s that we all took for granted in 2007-2008 are a thing of the past and I know most people wish they would have locked in a couple more 5 year CD’s at these rates.  So in today’s market, what are the best options for investors looking to earn a high return and minimize risk?

There are plenty of high return investments out there like Lending Club or investing in real estate, but these generally come with much higher risk.  CD’s are generally thought of as one of the safest guaranteed-return investments around.  But with interest rates at a 10 year low, is it worth it to invest in a paltry 1% CD while inflation is at 3% annually?

The Safety of a Certificate of Deposit(CD)

CD’s are risk-free in nature because they are insured by the Federal Deposit Insurance Corporation(FDIC) up to $250,000.  So as long as you have less than $250,000 in your CD, you will never lose that money.  Generally, in exchange for keeping your money for an intended period of time, banking institutions will pay you a higher rate than a typical savings or checking account.  You are giving up the liquidity on your money in order to achieve a higher interest rate.  The longest term most banks will offer is 5 years and that generally pays the highest interest rate.

Using google advisor, we can do a quick comparison of some of the highest rates around as of today(7/7/2012):

Bank APY Term Minimum Interest earned Early withdrawal penalty
Mission Federal Credit Union 1.95% 5 years $2,000 $512   None
Discover 1.75% 5 years $2,500 $457 6 months interest
Ally Bank 1.72% 5 years $0 $449 60 days of interest

I included a local credit union, Mission Federal, because local credit unions usually have very competitive rates.  I would never open a CD at a large brick and mortar bank like Chase or Bank of America because of their low rates and high fees.  The credit unions and online banks have a lot less overhead, thus allowing them to offer much higher rates.  I haven’t used Discover before, but as you can see they have very competitive rates with Ally, which I highly recommend.

I do have a brick and mortar bank for emergencies, but I do most of my banking online with Ally.  In fact, I’ve decided to switch my emergency fund and all of my savings to 5 year CD’s at Ally.  With a 5 year CD, I get the highest rate they offer and there is only a 60 day interest penalty on an early termination.  60 days is unheard of among the big national and online banks for an early termination penalty.

Using 5 Year CD’s to Keep Cash Liquid

I plan on taking most of my savings and all of my emergency fund and putting them into $5,000 5 year CD’s.  So if you have $10,000 in savings and $5,000 in emergency funds, you would open three 5 year CD’s of $5,000.  This will allow me to only break one of the CD’s should I need a few thousand in cash for an emergency.  This strategy works best with Ally because of their 60 day termination fee.

In fact, there’s really no reason to open anything less than a 5 year CD because the break-even point is so short.  Let’s take a look at an example:

Joe opens a 1 year CD for $10,000 at Ally currently(as of 7/7/12) paying 1.02%.  Aaron opens a 5 year CD for $10,000 at Ally paying 1.72%.  Compounding interest monthly(Starting balance * [1 + Interest Rate/12]), we can see that after just 5 months, Aaron can cancel his 5 year CD and have the same value as a 1 year CD.

Interest   Rate 1.02% 1.72%
Starting Balance $10,000 $10,000
Month 1 $10,009 $10,014
Month 2 $10,017 $10,029
Month 3 $10,026 $10,043
Month 4 $10,034 $10,057
Month 5 $10,043 $10,072

After just 5 months, if Aaron were to close his CD, he would receive $10,072 – ($10,072 – $10,043 = $10,043.  So the break-even point is only 5 months in this case.  If you can hold onto a 5 year CD for just 5 months, you’ll always come out ahead when compared to a 1 year CD at these rates.

Half a percentage may not seem like a big deal now, but when your account values start to grow, a percentage here and there can make a huge difference.  As long as the early termination penalty stays this small, there’s no reason to go with anything other than a 5 year CD.  The 5 year CD will let you keep the flexibility of liquid cash while still earning the highest rate available with a guaranteed return.

Readers, do you see any reasons not to use this strategy?  Ready to sign up with Ally(affiliate link)?

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-Harry @ PF Pro

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Hi, I'm Harry, the owner and head writer for Your PF Pro. I started this site back in 2011 in order to create a place where young professionals could come and get all of their financial questions answered. On the site, you'll find articles on everything from asset allocation for retirement to saving money at Chipotle! So enjoy..

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  1. JY says

    Thanks for this article. This seems like a great idea. But I wonder if some sort of CD ladder will make sense once the rates start going back up.

    • says

      If you use 1 or 2 year CD’s to ladder like I describe here: Building a CD Ladder. You still have to remember that if rates go up on a 1 year CD, they also go up on a 5 year CD. So with a 5 year CD, you will always be able to cancel and have that breakeven point apply. Make sense? I made a google spreadsheet here with a few scenarios.. .

  2. says

    As said this may not make a great deal now. But after sometime will make a great difference. Thanks a sharing an informative post.

  3. says

    0.5% doesn’t mean a great deal at a small amount of money, but it starts to mean more as your accounts grow in value. As my down payment account grew larger, seeing how much more interest it was earning was pretty cool.

    I think that laddering CDs is a pretty cool idea

    • says

      Most definitely. This strategy eliminates the need to ladder CD’s though. I just took my EF and savings account and opened up $5,000 5 year CD’s.

      I’m actually looking into I bonds right now, since I found out there is only a 3 month’s interest penalty if you redeem them before 5 years and they are currently paying 2.2%!

      • Mike says

        First comment, just discovered your blog today. Very good stuff!

        The 5 year CD sounds like a great alternative, even to a high yield savings account.

        Did you decide to pursue I Bonds? I just started learning about these and EE Bonds, but it isn’t clear to me yet what the best strategy is.

        • says

          Thanks Mike! I’m glad you like it. This strategy is much simpler than laddering CD’s and it gives you the best return. I’m honestly not sure why people don’t recommend it more, but it’s worked really well for me.

          I’ll have an article out soon about I Bonds, still doing a little research on them. But I think I’ll definitely putting in 10k this year, the rate’s currently at 2.2%.


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