With CDs paying over 5% APY, ask yourself 3 questions before signing up for passive income

A CD offers a higher interest rate in exchange for leaving funds for a specific length of time. Ask yourself if you need that money in the short term to decide if a CD is right for you.

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• A CD earns a fixed interest rate, but you have to leave your money in it for a set amount of time.
• Ask yourself whether you have separate emergency savings, and if you should be investing instead.
• Consider a high-yield savings account if you think you may need to access funds soon.

A CD (certificate of deposit) is a great place to save money for a fixed period of time in exchange for a higher interest rate than what would be offered saving in other bank accounts. Right now, the best CD rates are topping 5%.

CDs are a great way to generate passive income because they require almost no oversight after the initial deposit. This is definitely a "set it and forget it" financial move that can help your money grow. 

While saving with a CD is going to earn you more money, thanks to its guaranteed return and reduced risk, it's not the only option for seeing your funds grow, and depending on your situation it may not be the best move for you.

Here are three questions to ask yourself before signing up for a CD:

1. Once I open this CD account, can I leave the money there? 

When you open a CD and deposit money, you are agreeing to keep your money in that account for the entire term, which can range from a few days to five years or more. Typically, the longer the term, the higher the interest rate, but the question is: Can you afford to leave the money in the account for the agreed-upon length of time?

If something happens and you need that money before the CD maturity date, you will typically pay an early withdrawal penalty in the form of a portion of the interest earned. 

If you're not sure you'll be able to leave your money parked in a CD for the entire term but you want to maximize the return on your money, consider a high-yield savings account instead. High-yield savings accounts pay much higher interest rates than regular savings accounts, but unlike with CDs, there's no penalty for withdrawing money at any time.

2. Do I have savings elsewhere in case of an emergency?

Make sure you have savings in an emergency fund in case you need money quickly. A CD is not the place for everyday savings or an emergency fund; it is an account where you put money that you know you will not need for a while.

Before opening a CD, make sure you have savings in other accounts, whether it's short-term savings or an emergency fund. That way, when you deposit funds in a CD, you can leave it there.

3. Should I invest this money instead?

Opening a CD is a great way to earn a little extra on your savings and watch your money grow a bit faster, but you won't see huge returns. This account type is going to be better for short-term savings, but not for retirement. So ask yourself: Should I be investing this money for longer-term goals instead? 

For example, if you get a $25,000 windfall and you already have everyday savings, an emergency fund, your retirement is on track, and you don't have any immediate financial needs, then yes, a CD for 3 to 5 years would be a great place to put your money and earn a little extra.

But if you are still trying to get your retirement savings on track, then investing for the long-term through an investment app, IRA, or 401(k) would serve you better in the long run. 

This article was originally published in July 2023.