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6 surprising ways to use CDs for money management

September 01, 2010

| MoneyRates.com Senior Financial Analyst, CFA

When considering a certificate of deposit, most people tend to focus on the tradeoff between CD rates and the length of commitment. That's because the longer you are willing to lock up your money, the higher CD rates tend to be.

Although choosing the right CD term at the right interest rate is certainly important, the timed maturity feature of a CD lends itself to a few surprising uses.

Creative--and financially savvy--ways to use CDs

Here are six ways to use CDs in a way that takes advantage of the account's features:

  1. Earmarking your spending. If you've been saving a sum of money for a specific purpose, such as for a home down payment or a new car, matching a CD term to the timing of that need can be the ideal way to handle the cash in the meantime. Particularly if you don't need the cash for more than a few months, chances are you'll find that interest rates for CDs of longer terms are higher than savings account rates. An added bonus is that locking the money up will help you avoid dipping into those funds on a short-term impulse.
  2. Managing your cash flow. Take the above example, and multiply it for a series of future needs. Rather than creating a traditional CD ladder--a series of CDs with different maturity dates--with evenly spaced maturities, you may find yourself laddering your CDs to match specific future cash flow needs.
  3. Hedging against falling bank rates. When you think bank rates are attractive and are concerned they might fall, locking into a long-term CD gives you some protection. Imagine if you'd bought a long-term CD a couple of years ago--you'd still be enjoying interest payments several percentage points above today's CD rates.
  4. Holding your emergency reserves. You should have some emergency reserves in savings or money market accounts for immediate access, but if you are able to build up reserves beyond six months worth of normal cash needs, why not put some of those longer-term reserves in CDs? Even in an emergency, it's unlikely that you'll need all your emergency reserves in cash at a single point in time. If you're still concerned about liquidity, look for CDs with lower early-withdrawal penalties.
  5. Diversifying your portfolio. Most individual investors are aiming for a mix of stocks, bonds and cash. If the cash portion of your portfolio is for financial stability and not day-to-day expenses, you might as well can earn a higher yield by putting it into a CD.
  6. Deferring your decision. Sometimes, you just want an interim financial position until things change. For example, if you feel that interest rates are bound to be higher a year from now, a one-year CD could get you some extra yield now without locking your rate for too long. That way, you defer making a longer-term financial decision until you see where bank rates stand next year.

Product features such as CD rates and terms are still important, but often the starting point should be your financial goals. Once you define how a CD might suit your needs, it'll be all the easier to select a term and then shop for the best CD rates for that term.

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