How Much Should You Put Into a CD? Here's One Way to Decide

Image source: Getty Images

Certificates of deposit (CDs) have gotten a lot of press the last couple of years, and with good reason. We're currently sitting at a high federal funds rate, which was the Federal Reserve's response to high inflation in the wake of the COVID-19 pandemic. Thankfully, this move seems to have worked -- as of the most recent Consumer Price Index Summary report, inflation is finally under 3%.

What happens now? The Federal Reserve is expected to start cutting the federal funds rate this month, and APYs on CDs, savings accounts, and other deposit accounts are likely to start falling as well. Before you rush to open a CD, take a moment and consider how much money you can put into one.

How much cash can you part with on a (relatively) short-term basis?

CDs are a pretty low-risk proposal, with one caveat: You can lose some of your money to a penalty fee if you withdraw your funds before the term is up. You could forfeit some or all of the interest you earned to cover an early withdrawal penalty.

And if you haven't had the CD open for long enough to have earned the amount of the penalty (for a 1-year CD, that could be three months' worth of interest), you could lose some of the money you put into the CD. That's not ideal, so it's worth thinking about how long you can keep your money locked up.

If you're deciding how much you should put into a CD, you need to consider your timeline for the cash. Want to take a sweet vacation in six months and grow your vacation fund a bit along the way? Opt for a 6-month CD . Have a child starting college in four years? A 4-year CD could be a great place to keep that tuition money safe and growing.

Keep this cash out of a CD -- no matter what

CDs are excellent for those bits of money with a defined timeline, if you're confident you won't need the cash earlier than that. But you might have savings that absolutely doesn't belong in a CD, no matter what: your emergency fund.

By definition, an emergency fund is money you have saved for an unplanned expense of some kind, like a surprise car repair. It can also help you cover your regular bills in the event of a layoff or other issue that sees you out of work for a period.

Since your emergency fund should always be at the ready for you, don't lock it up in a CD. Keep it in a high-yield savings account instead.

What about money with a longer timeline?

Finally, you may also have money that you're hoping to put toward a far-off goal, like retirement, a vacation home purchase in a decade, or college for a child who is currently an infant. This money doesn't belong in a CD either, for one simple reason: You won't get the kind of returns you deserve on it.

Remember, CD rates in the 4% and 5% range are not the norm. But if you invest money for far-off goals rather than locking it up in CDs, you could enjoy returns of double that. The stock market has returned an average of 10% annually for the last five decades, accounting for good years and bad. This is why investing is best and least-risky as a long-term prospect.

If you're saving for retirement, consider contributing to your company's 401(k) or other retirement plan (especially if your contributions are matched -- free money!), or open an individual retirement account (IRA). You can save on taxes -- either now, in the case of a traditional IRA or 401(k), or later, in the case of a Roth account. And you'll likely enjoy more growth than you would from CDs.

Are CDs right for you?

For the right person and the right situation (namely, a short-term savings timeline), CDs can be a great way to protect your money from inflation and earn some interest along the way. Just be sure you can afford to part with whatever target you land on to open one. Early withdrawal penalties can be a bummer for your finances.

Alert: highest cash back card we've seen now has 0% intro APR until nearly 2026

This credit card is not just good – it's so exceptional that our experts use it personally. It features a 0% intro APR for 15 months, a cash back rate of up to 5%, and all somehow for no annual fee!

Click here to read our full review for free and apply in just 2 minutes.

We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy .