What To Do When A CD Matures (EP.168)

0:28We all need to make smart decisions with our money. you might be facing or will face soon, and that's what to do when a CD matures. We'll explore the factors you should consider, strategies to maximize your earnings, and whether you should renew your CD, move to a high-yield savings account, or even explore some higher-risk, higher-reward investments. But as always, I like to start with the basics, which in this case is understanding what it means for a CD to mature. When you purchase a CD, you're essentially lending your money to a bank for a set period of time known as the term. During this term, your money's locked away, earning interest at a fixed rate, which is often higher than what you'd get from a traditional savings account.

1:14But unlike a savings account, the trade-off is that you can't touch the money without paying a penalty until the term is up. Now, when we say a CD has matured, what we mean is that this term has come to an end. The CD has reached its maturity date and the bank is now required to return your original deposit along with any interest it has earned over the term. The bank will typically notify you a few weeks beforehand, either by mail or electronically. And this notification, it's your cue to start thinking about your next move. If you don't take any action, the bank may automatically roll your funds into a new CD with a similar term, but this new CD may have a different interest rate and it might not be the best option available to you.

2:05So it's this moment that you ought to consider a few factors. The first being current interest rates. Now, interest rates are going to fluctuate over time based on economic conditions, and the rate you can get today might be very different from what you locked in when you first opened your CD. For example, imagine you've been buying three-month CDs for the past year or two just because rates were higher than what you could earn in most bond funds. To make my math easy, let's just assume that your annualized rate of return on those three-month CDs was 5.09 % because that comes out to 1.25 % in actual earnings every three months.

2:47But maybe today the new three-month CD rate is just 4.7 % because the Federal Reserve has been telegraphing the start of a rate-cutting cycle. Now, 4.7 % is still a decent annualized rate, assuming that you can continue to reinvest at that rate three months from now, but that isn't something that you can necessarily count on with the Fed signaling rate cuts. In a more normal rate environment, investors will earn higher returns for locking in their money over longer periods of time. And so if you didn't have any need for the money, you might consider locking in a longer term rate. but current market yields are such that short-term rates are higher than long-term rates, a scenario referred to as an inverted yield curve.

3:39So that doesn't really apply at this point in time. The next factor to consider is liquidity. Because one of the main downsides of a CD is that your money is locked away for the term and accessing it early can result in penalties that eat into your earnings. So when your CD matures, it's an opportunity to reassess your liquidity needs. So ask yourself, do I need access to this money in the near future? Perhaps you have upcoming expenses like a home renovation or a large purchase or even a planned vacation. And if that's the case, renewing the CD for another term might not be the best option. You might just be better off cashing out and moving the money into a more liquid account, like a high-yield savings account where you can access it without penalties.

4:28The most important factor to consider, however, is going to be your broader financial goals. So think about what you want the money to do for you. Are you saving for retirement? Are you building an emergency fund or some sort of cash reserve? Or maybe just setting aside money for a future major purchase? If the money in question is earmarked for a long-term goal like retirement, you ought to consider some higher risk, higher reward options, like investments that we'll talk about a little bit later. But if you're saving for a short-term goal, like buying a car, for example, in the next couple of years, a shorter-term CD or a high-yield savings account might be more appropriate.

5:13And so let's dig in here a little bit more, because both CDs and high-yield savings accounts are low-risk savings vehicles, but they also have their unique advantages and drawbacks. When we think about CD renewal, that is probably going to be the most straightforward option, especially if you're comfortable with the fixed term commitment and the guaranteed return. Because when you renew a CD, you're essentially reinvesting your principal and any earned interest into a new CD, locking in the current interest rate for another term. Now, the benefits of this approach is that there's that guaranteed return.

5:50I know a lot of people find that to be the most appealing aspect of the CD is just the certainty that provides, you know, exactly how much interest you're going to earn over the term. And that can be reassuring in a volatile market. And also CDs have the FDIC insurance, making them a very safe place to park your money. And typically, the longer the CD term, the higher the interest rate. So if you don't need access to your funds for several years, renewing into a long-term CD could offer you a better rate than a savings account. However, right this very moment, as I mentioned, short-term rates are higher or equal to long-term rates, so that doesn't necessarily apply right this moment.

6:33Now, the drawbacks of a CD renewal are something that we already talked about, which is limited liquidity. I think that's really the main downside because your money gets locked in for the duration of the term, and if you withdraw anything early, it results in penalties, which can sometimes negate all the interest you've earned. The other downside can be the fact that they are fixed rate. So while the stability of a fixed rate is beneficial in a falling interest rate environment, it can be a drawback if rates rise after you renew the CD because you'll be stuck with that rate you locked in until the CD matures again.

7:12Now, on the other side of the coin, we have a high-yield savings account that offers more flexibility while still providing competitive interest rates. And they become increasingly popular among consumers just because they typically offer a much higher interest rate than a traditional savings account without that long-term commitment of a CD. So that liquidity is probably the biggest benefit of the high-yield savings account. The variable interest rates is also something that can be attractive because your rates can go up or down over time depending on the interest rate environment. And much like liquidity, there's just no penalty for the early access.

7:53So you can transfer your funds quickly and easily between accounts online, which really makes it a convenient option for managing cash flow. Now, the primary drawback of the high yield savings account, I suppose, would be that they typically have lower rates than CDs. And that variable rate, which I mentioned can be a good thing, it can work against you. So the variable rates tend to work in your favor in a rising interest rate environment, whereas in a falling interest rate environment, the variable rates will lead to a lower return on that cash than if you had locked in a rate with a CD. So generally speaking, if I had to boil down the choice between a CD and a high yield savings account, the two things that I really think most about are the need for flexibility.

8:42So if you know exactly when you're going to need your money, perhaps a CD becomes more palatable, particularly if you can earn a higher rate. But the other thing is, if you're using this money for a short-term goal like an emergency fund or a cash reserve, that's going to tip the scales towards a high-yield savings account. And I think ultimately what I'm explaining here is that the choice between renewing a CD and moving to a high-yield savings account really just depends on your individual financial goals and your need to access the funds. Because your view on where interest rates might be headed might be right and it might be wrong.

9:21And I think that really acts as a nice transition into the final consideration, which is, should we be thinking about some higher risk, higher reward investments? Because generally speaking, I think of CDs as a cash equivalent. And so the question here really is, should you invest in cash or some mix of stocks and bonds? And earlier, I noted that the major factors to consider when you're thinking about what to do when a CD matures were the current interest rates, your liquidity needs, and your financial goals. But when I think about the choice of just cash versus investing in a mix of stocks and bonds, I don't really think you should let current interest rates influence your decision too much.

10:05And here's why. If the money is intended or needed for long-term goals, we can't reliably predict future interest rate movements such that we would know the perfect time to get out of cash and into a diversified investment portfolio or vice versa. I mean, that's just simply an acknowledgement that nobody can time the market. And in the show notes at thelongterminvestor.com, I'm going to drop in a chart from this quarter's webinar that I published showing annual asset class returns going back to 2008. And cash is one of the asset class shown. And you will see that there are years in which cash is the winning asset class.

10:46But like any other equity or fixed income asset class, we can't know in advance when it will win and when it will lose. I really like this chart. Some people call it a periodic table. Some people call it like the asset class quilt, but it's a really nice visualization of different asset class performance, as well as how a diversified portfolio that owns all these asset classes performs. And by the way, I'll also be sure to include a link to the webinar recording, which is something I do every quarter. I just often forget to talk a little bit about it on this podcast. So again, go to the longterminvestor.com to check that out.

11:22And as you're looking here and you're thinking about cash versus a diversified portfolio of stocks or bonds, Yes, stocks and bonds will regularly experience bouts of volatility and temporary losses, but those losses and the related uncertainty are simply the cost of the higher expected returns you earn relative to cash. It's not really that losses are even the enemy here. It's actually the need to liquidate during periods of market volatility. So if you have a short-term need for the cash, let's say it's something less than five years away, then keeping the maturing CD assets in a cash or cash equivalent option might make more sense.

12:06Now, personally, I prefer the flexibility of a high yield savings account, even if I really do have a lot of foresight into when I'll need the money. But a CD might be more beneficial for those who really do feel like they have perfect foresight and prefer the certainty of locking in a specific interest rate. So as we recap today's episode, we have covered what to do when a CD matures. You have several options from renewing the CD, moving the funds to a high yield savings account, or exploring higher risk, higher reward investments. And each choice comes with its own set of benefits and drawbacks.

12:44And the best option for you is really going to depend on your financial goals, your risk tolerance, and your time horizon. Remember, the key is to make an informed decision with this money that aligns with your overall financial strategy. As always, thank you for tuning in to The Long-Term Investor. And if you found this episode helpful, please leave a review and share it with others who might benefit. That is how the show keeps growing and keeps helping more people make good decisions with their money. As always, if you have any questions, need any further guidance, don't hesitate to reach out and until next time to Long-Term Investing.

13:49is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.