When you have extra cash that you don’t necessarily need immediate access to, one way to make it work harder for you (i.e., earn some money) is by opening a certificate. A certificate can be referred to by many names – certificate of deposit, CD, time deposit, share certificate or, as we like to call them, certificates.
But how long should you keep your money in a certificate? And is there a difference between choosing a shorter-term versus a longer-term certificate? To answer these questions, we brought in our expert, Ron VanSkiver, assistant vice president of retail financial services at Centris Federal Credit Union.
Understanding Certificates
A certificate is a way for you to earn money on your money. Certificates guarantee a return on your investment, and they achieve this by operating as a time deposit account. This means your money is locked away, earning dividends for a specified period or term.
Now, while a certificate is a great way to save, it’s not a replacement for an actual savings account. Instead, think of it as a supplement to your overall savings strategy. VanSkiver recommends having “a savings account for the cash you know you’ll need soon, and as a holding place to save additional funds for longer-term goals. Once these additional funds have accumulated, they can be invested in a certificate to earn money on your money.”
But why? “When you open a certificate,” explains VanSkiver, “you are locking that money away for a specific term length. But the trade-off is earning a higher rate of return (often referred to as interest or dividend) and having the money put aside for a long-term goal.”
How Certificate Terms Work
One advantage of certificates is that they are available in a variety of term lengths. Term length refers to the duration for which your money will be locked in the certificate.
Term lengths can range from short-term, such as 3 to 12 months, to long-term, such as two years, three years, and so on, depending on the financial institution.
While your money is in the certificate, it earns a stated fixed annual percentage yield (APY) until the end of the term or until its maturity date. At maturity, you’re free to withdraw your money and earnings or renew the certificate at the current rate being offered.
VanSkiver says it’s important to remember that “there is no inherent difference between a short- and long-term certificate. The product functions the exact same way — it’s more about choosing which is the right fit for you, depending on your goals.” That’s why it’s essential to carefully consider your certificate term.
What Are Short-Term Certificates?
A short-term certificate is a certificate with a term length of 3, 6, or 12-months, or those in between.
Benefits of Short-Term Certificates
A short-term certificate can be beneficial for those looking for:
- Flexibility and faster access to funds. When you choose a shorter certificate term, you have more flexibility because your money isn’t locked away as long, allowing quicker access to your funds.
- Less risk in a rising interest rate environment. With a short-term certificate, you’re less likely to get stuck in a certificate with a lower dividend rate. “And if you do,” says VanSkiver, “you have a shorter amount of time to ride it out until you can renew it with a certificate that has a higher rate.”
- A parking spot for short-term savings goals. Short-term certificates can be great avenues for parking different savings that you know you won’t need for anything else. For example, if you’ve already saved enough for your vacation next year and want to earn some money while you wait to use those funds, a short-term certificate may be a great option.
Trade-Offs of Short-Term Certificates
Short-term certificates are great for some things, but not for others. VanSkiver points out that short-term certificates “usually have a lower APY, meaning you’ll earn less dividends; however, this can vary during uncertain economic times, causing the shortest terms to have the highest rates. So, it’s best to price different certificate terms before investing.” And since the term is shorter, you’ll be faced with more frequent decisions about what to do with that money next, like whether you want to renew your certificate or move it to a new savings account.
What Are Long-Term Certificates?
A long-term certificate is a certificate with a term length of 15, 24, 36-months or longer and those in between.
Benefits of Long-Term Certificates
A long-term certificate can be beneficial for those looking for:
- Higher dividend rates. Traditionally, long-term certificates have had higher dividend rates than short-term certificates. This means you’ll earn more money over a longer period. Again, keep in mind, it’s always good to price different certificate terms.
- Locked in dividend rates. Since the dividend rate is locked in for the term of the certificate, a long-term certificate can be a good choice if you think rates are likely to go down.
- A place for longer financial goals (e.g., saving for a house, education). A long-term certificate can be a great place to meet your savings goals. VanSkiver provides an example, saying that “long-term certificates are beneficial when you have a lump sum saved for a long-term goal and immediate access to the funds isn’t needed. Saving for education costs is a good example.”
Trade-Offs of Long-Term Certificates
There are some trade-offs associated with long-term certificates. For example, if you lock in a certificate for 15-months, but need the money before the certificate matures, you’ll likely have to pay an early withdrawal fee. Long-term certificates are also less flexible in a changing rate environment, which can be beneficial in a decreasing rate environment, but unlucky in an increasing rate environment.
Key Factors to Consider When Choosing a Certificate
VanSkiver advises that “whether you get a short- or long-term certificate is entirely up to your financial situation and goals.” Here are some things to think about when making your decision.
Your Savings Timeline
When considering your savings strategy, categorize your short-term and long-term savings goals. From here, it’ll be easier to determine if a short- or long-term certificate would benefit you the most.
“Your short-term goals should align with a short-term certificate most of the time,” says VanSkiver. “And your long-term goals should go with a long-term certificate.” And if your goal is somewhere in the middle, there’s likely a certificate term for that, too!
Interest Rate Environment
Another thing to consider is the interest rate environment, especially if you aren’t sure about the term length but want a good dividend rate.
VanSkiver says to “price different certificate terms and then determine if interest rates are likely to go up or down in the near term. If rates are going up, short-term certificates will reprice at higher rates and may be more attractive. If rates are largely staying steady or if the movement is slow, you may want to go with the certificate term with the better rate within your investment timeline. And if rates are going down, long-term certificates will lock in the current higher rate for a longer period before repricing to a lower rate.”
Not Sure Which One to Choose? Consider Certificate Laddering
If you really can’t choose, don’t panic – there may be an option for you! It’s called certificate laddering, an investment technique that allows you to blend liquidity with higher dividend returns.
By laddering certificates, you’re basically splitting up your lump sum into however many certificates you’d like and locking them in at different terms.
For example, let’s say you have $3,000 you’re willing to put into a certificate, but can’t decide what term to choose. You want to ensure that you can access some of these funds within a reasonable timeframe while still earning high dividends. You could split that $3,000 into three separate certificates, each with a different term. Let’s say you put $1,000 into a 12, 24, and 36-month certificate. By doing so, you’ll have cash become available at different times and earn the traditionally higher rates of the long-term certificates.
Who Should Consider Laddering?
“Laddering can be a great technique for anyone wanting regular access to their funds and who is uncomfortable trying to outguess the timing of interest rate movements. Even the most seasoned investor can’t always forecast the timing or direction of interest rate changes, so certificate laddering can provide a middle ground,” mentions VanSkiver.
It can be a good option for long-term goals, such as saving for education costs, or can be achieved on a smaller scale with shorter certificate terms.
Final Thoughts: Choosing the Right Certificate for You
Certificates can be a valuable addition to a savings strategy, and choosing the right certificate term depends on your goals. Before you open a certificate, VanSkiver encourages you to “think about your goals and determine if you’ll need that money at any point within the term length.”
At Centris Federal Credit Union, we have a range of certificate terms to fit your needs and goals. We also offer our Certificate and Savings Account Bundle, which allows you to earn dividends on both a certificate and a savings account, providing the flexibility to lock in a certificate while maintaining peace of mind with liquid cash.
Have questions? We’re here to help. Click here to schedule an appointment to chat with a team member to learn more about your options.
