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Investors who park savings in a certificate of deposit may be short-changing themselves with their CD choice.
And that mistake can prove costly for investors who feel an impulse to flee the stock market amid a steep downturn being fueled by President Donald Trump’s tariff policy and fears of an escalating global trade war.
“When it comes to buying CDs, it pays to shop around,” said Winnie Sun, co-founder of Irvine, California-based Sun Group Wealth Partners and a member of CNBC’s Financial Advisor Council.
Why consumers may be ‘shortchanged’
CDs have a set term, ranging from a few months to five or more years. Upon maturity, banks return the depositor’s principal plus interest.
Consumers who want their money early must generally pay a penalty, losing out on months of interest.
However, paying that withdrawal penalty may be worthwhile for savers who adopt the right strategy, according to a recent research paper by Matthias Fleckenstein, associate professor of finance at University of Delaware, and Francis Longstaff, finance professor at the University of California, Los Angeles.
Specifically, consumers can often get a higher financial return by choosing a long-term CD and paying a penalty to pull money out early, relative to simply picking a short-term CD, the researchers found.
Investors who are unaware of the strategy may get “shortchanged” by banks, Fleckenstein told CNBC.
‘The rule rather than the exception’
Here’s an example: If an investor puts $1 in a five-year CD with a 5% interest rate and cashes it out after one year with a penalty equivalent to six months of interest, they would receive about $1.03, which is slightly more than the $1.01 they would get from a one-year CD with a 1% interest rate, despite the penalty incurred for early withdrawal.
Banks frequently price CDs this way, Fleckenstein and Longstaff wrote in their paper, published in October in the National Bureau of Economic Research.
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The researchers examined weekly CD rates offered by 16,891 banks and branches — ranging from small community banks to big nationwide institutions — from January 2001 to June 2023. Rates were for accounts up to $100,000.
About 52% of CDs offered during that period had such “inconsistencies” in pricing when comparing a given term against a longer-term CD cashed in early, they found.
“It’s the rule rather than the exception,” Fleckenstein said.
“There are banks that do this all the time,” he said, and “there are some that don’t do this at all.”
At banks where this happens, the difference in returns “is not tiny,” Fleckenstein said. In fact, the pricing inconsistency is about 23 basis points, on average, over the roughly two decades they assessed, he said.
Given that disparity, the average investor who invested $50,000 could have gotten an extra $115 of interest by picking a longer-term CD and cashing it in early, their research suggests.
The average size of that pricing difference rose as interest rates began to increase during the Covid-19 pandemic, Fleckenstein said.
CDs often for ‘safety and liquidity’
About 6.5% of households held assets in CDs as of 2022, with an average value of about $99,000, according to the most recent Survey of Consumer Finances.
Certificates of deposit may be a “great fit” for someone looking for a safe yield — whether someone near retirement, already retired, planning a home purchase in the near future or even a younger investor seeking peace of mind. However, consumers shouldn’t “panic-sell” their stocks and move proceeds into CDs, Sun said.
“Selling at dramatic lows and moving into CDs translates into locking in losses that your financial plan may not be able to absorb,” Sun said.
Like any investment, there are pros and cons to CDs.
For example, unlike other relative safe havens like high-yield savings accounts or money market funds, CDs offer a guaranteed return over a set period with no chance of market-based losses. In exchange, however, CDs offer less liquid access to your cash than a savings account and lower long-term returns than the stock market.
“Shop around for the best CD rate across banks, but also look within banks at whether it actually may pay off to accept a longer term but pay an early withdrawal penalty,” Fleckenstein recommended, based on his research findings.
Current market may offer few chances for strategy
The option may not be as prolific in the current market environment, though.
Long-term CDs typically pay a higher interest rate than shorter-term ones, Sun said. But average rates for one-year CDs are currently higher than those for five-year CDs: about 1.9% versus 1.6%, respectively, according to Bankrate data as of March 31.
Households can pursue other CD strategies, Sun said.
For example, instead of putting all savings into a long-term CD, consumers might put a chunk of their money into a long-term CD and with the remaining funds build a “ladder” of shorter-term CDs that mature more quickly. They can then buy more CDs if they’d like once the shorter-term ones come due.
