Should You Buy a 3-Month, 1-Year, or 5-Year CD? Here's How to Decide

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If you decide that you want to add some certificates of deposit (CDs) to your portfolio, you'll have an important choice to make: You're going to have to decide what CD term makes sense for you.

You'll have lots of choices, as CD terms typically range from three months to five years. This decision is an important one, as your rate is guaranteed for the duration of the term, but your money also has to be kept invested for that long as well in order to avoid penalties.

To help you decide whether to buy a 3-month, 1-year, or 5-year CD (or something in between those ranges), here are four key factors to weigh.

1. Evaluate the yields each CD is offering

The rate you'll be offered for your CD varies depending on the term. As of the end of April 2024:

• You can find plenty of high-yield CDs with three month terms with rates paying somewhere around 4.00%, while some pay as high as 5.30%.

• The Ascent's list of the best 1-year CDs has more than a dozen paying rates above 4.50%, including seven CDs with rates of 5.00% or higher.

• The best 5-year CDs on The Ascent's list mostly have rates in the 3.75% to 4.00% range, with no 5.00% options available.

If your goal is to maximize your returns in the short term, a 1-year CD would probably be your best bet. It guarantees your rates for longer than a 3-month CD, giving you more chance to earn a great yield. And it provides a considerably better return on investment (ROI) than a 5-year CD.

2. Consider whether rates are likely to go up or down

You'll also have to consider whether you believe rates are going to trend up or go down. If you think there's a good chance interest rates will rise and CD rates will climb higher, then you won't want to commit your money for too long. You could get trapped in a CD when there are way better offers out there in the future.

On the other hand, if you're concerned rates will fall, then you can expect CD yields to decline. You might want to opt for a 5-year CD (even though it doesn't pay as much as a 1-year CD), since the current return on investment for 5-year CDs is great by historic standards and you'll get to keep that great rate for a long time.

3. Decide when you'll need to access the money

There's another really important thing to think about as well: When will you need the funds you're investing?

You don't want to pull money out of a CD early because you can face hefty penalties for doing so. So be sure you're OK with making the time commitment. In fact, even if you think rates will go down and you'd love to get your money into a 5-year CD to guarantee you can keep earning at today's generous yields, you shouldn't do that if you think there's a chance you're going to need the money before the CD matures.

4. Think about the opportunity cost of tying up your funds

Finally, you have to think about what you're giving up if you tie up your money in a CD. You can't use that money to do other things, like paying down debt. And you can't invest it in the stock market, where it could earn a higher return than CDs offer. You're also stuck if interest rates go up and could lose the opportunity to invest in CDs offering a higher ROI.

If you won't need the money for more than five years, it probably doesn't belong in any CD at all. In this instance, you can open a brokerage account and buy shares of an S&P 500 fund. The S&P 500 has consistently earned 10% average annual returns over the long term.

But if your time window is shorter, still take the time to think about just how long you're OK with giving up your ability to move that money into another investment. If you don't want to give up the chance to get the funds into the market for years to come, committing to a 5-year CD probably doesn't make sense.

By considering these four issues, you can decide which CD term is right for you. Once you've done that, check out The Ascent's guide to the best CD rates and find a CD with the right timeline that's offering you a great rate today.

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