A certificate of deposit is essentially a savings account that offers a fixed interest rate in return for your agreement to lock up the money for a period of time. Banks usually require a minimum deposit, but you can put in more than the minimum. Deciding how much to put into a CD is a balancing act between getting the highest interest rate available and ensuring you have access to the money if and when you need it.
Most banks and credit unions require a minimum deposit to open a CD. This minimum can be a few hundred dollars all the way up to tens of thousands, and you are free to deposit more than the minimum. Opening a CD with just the minimum offers the most flexibility, but you may earn a higher interest rate if you commit a larger amount of money. If you have six figures to invest, you can both earn a higher rate and retain flexibility by opening a negotiable jumbo CD.
Special Investment Accounts
If you are opening a CD within a special type of investment account, such as an IRA, you also have to comply with IRS restrictions. For example, in 2013, you can’t invest more than $5,500 in an IRA for the year, or $6,500 if you are 50 or older. If you want to open a CD within an IRA at a bank, but the bank requires a minimum deposit of $10,000 in its CDs, you are out of luck.
Early Withdrawal Penalty
In general, CDs offer a fixed rate of interest over time in exchange for your agreement not to withdraw the deposit during the term. To enforce this agreement, the bank will impose an early withdrawal penalty, usually requiring you to forfeit a certain portion of the interest you'd otherwise earn. You can minimize your losses in the event of an emergency by taking out multiple CDs, each in the amount of the minimum deposit. For example, if you have $5,000 to invest and the bank requires a $500 minimum deposit, you could open a single CD, but if you ever had to break it down the road, you’d forfeit interest on the entire amount. A more flexible choice would be to open 10 different CDs, each in the amount of $500. Then, if you got in a jam and needed to withdraw $1,000, you would only have to break two CDs, leaving the other eight intact.
By opening multiple CDs at varying times, or creating a "CD ladder," you increase flexibility and avoid the risk of missing out on higher yields if interest rates increase. For example, rather than investing $5,000 in a single CD, you could purchase five $1,000 CDs with one-, two-, three-, four- and five-year terms. When the first CD matures in a year, you can use the funds if you need them, or use them to purchase a new five-year CD if you don’t. With CDs staggered in this way, you will always have a CD maturing each year.
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