Short Term vs Long Term CDs

Which is Best? Short or Long Term CDs

A certificate of deposit or CD is relatively easy to set up, but it requires a little more thought when it comes to depositing money into the CD. The main issue is that a CD represents a considerable time commitment without ready access to those funds. An earlier than planned withdrawal, prior to the maturity date is likely to trigger an early withdrawal penalty. To deal with this problem, financial institutions have short and long term CDs. But, it’s important to understand how they work to ensure that you choose the right CD for your needs.

Understanding Your Financial Timeline

It’s hard to give a one-size-fits-all solution on which type of CD you should choose. Everyone has a different set of financial circumstances to deal with and what’s right for one person may not work well for someone else. So, it’s important to understand your own finances and have a clear idea about your financial timeline. Like most people, it’s likely that you’re planning to save cash in the CD to meet a specific need. This could be to pay tuition, fund a new home purchase, pay for a wedding or something else. Once you know when those events are likely to happen it’s easier to choose the right CD to meet those needs. Some people use a CD because they don’t need much ready cash right now and it seems like a waste to have it just sitting in a regular savings account. As a general rule, if you are in the former category, you may be looking for a CD that can last from 2-5 years. If you simply want to stash your cash where it can earn more interest, you may be better served with a one year CD that you can renew annually as desired. Let’s look at some more specific scenarios that further illustrate this basic concept.

If APY is the Priority Go with a Short-Term CD

This is usually the optimal solution because you can get a high annual percentage yield (APY) for a year or even six months! The main advantage is that your cash isn’t locked away for years. You can add money to a short-term CD and pull it out relatively quickly. There are three scenarios where a short-term CD can make a lot of financial sense:

• CD Rate Rises: if you’re expecting a rise in CD rates it makes sense to set up a short-term CD now to take full advantage of the current lower rates.

• Short-Term Saving Goals: This would be for things that you’re likely to want or need within the next year, such as: furniture, a vacation and more. 

• Avoiding Early Withdrawal Penalties: If you’re set on the idea of using a CD and you don’t want to get caught out with an early withdrawal penalty go with a short-term CD.

The only real disadvantage that a short-term CD has in comparison to a long-term CD is that the rates are usually lower. Banks tend to favor long-term savers with higher rates as an incentive. 

If Avoiding Fed Rate Cuts is the Priority Go with a Long-Term CD

The Federal Reserve is likely to lower its benchmark interest rate many times throughout 2024 and continue into 2025. Some financial experts believe that this trend may even extend into 2026 and this is bad news for regular savers. The rates that could be earned on savings in the next 1-2 years may be much lower than you expect. There are three clear scenarios where you may want to lock your money into a long-term CD:

• Interest Rate Stagnation: if you don’t anticipate CD interest rates to rise in the near future, it may be a good idea to make the most of a longer term product.

• Secure Savings: With all the financial turmoil that we’re experiencing you may be looking for a safe and secure place to keep your savings for the next few years.

• A Fully Funded Emergency Fund: You may have an emergency fund in place to cover your usual monthly expenses up to six months or a year or even longer. Any extra cash is unlikely to be needed for at least a couple of years to fund any short-term needs.

Long-term CDs have much better rates than short-term CDs which makes them a solid choice if you don’t need that cash on hand for other purposes. The banks will always use higher rates to entice their customers to save over the long-term.

Which is the Best Option?

As you can see, both have their own advantages and disadvantages to consider. A short-term CD is a good option to hold money at a higher rate for a short period of time and vice versa. A short-term CD can be a good way to hold funds for planned annual expenses such as a vacation, insurance premiums and more. The money is safe, extra interest is being earned and it will be ready to withdraw when you need it. The key to success is to choose the correct maturity term to maximize interest without paying early withdrawal penalties. For those that are well organized there is a way to combine the benefits of short-term and long-term CDs and this is referred to as CD laddering.

What is CD Laddering?

This is when a person stacks CDs to have them mature periodically to meet varying needs and earn extra interest. The concept is simple, the money is not placed into a single CD and instead it’s placed in multiple CDs that mature on different dates. So, you could have a CD maturing every 3-6 months and earn more interest at the same time.  There is no major inconvenience in waiting for years to access your funds. This technique works even better if you have some short-term and long-term CDs at the same time. The long-term CDs can be left to earn extra interest for longer and the short-term CDs mature on a regular basis to meet other financial obligations. The main drawback to this approach is that it can be difficult to keep track of every CD without some kind of planning app or a printable planner. Some guesswork can be taken out of CD laddering if you plan for a short-term CD to mature at the start of each quarter. Then you may have a long-term CD maturing at the start of each year.