The past few years haven’t been kind to savers. Interest rates have plummeted, and the typical online savings account is now paying just a bit more than 1% APY. Sure, CD rates are a little better, but you have to lock up your money for a relatively long period of time to do much better than a savings account. Or do you?
Today I want to share with you a little trick that we’ve been using to eke a bit more out of our “liquid” savings… Buy long term CDs from a bank with a small penalty for early withdrawal.
While many banks charge six months, or even a year of interest if you break your CD early, institutions such as Ally Bank have a short 60 day interest penalty. When you couple that with a decent five year CD rate, you can supercharge your savings with minimal risk.
Here’s how it works:
Start by opening an account with Ally Bank and then buy one or more five year CDs. These are currently paying 2.39% APY, which is roughly double what you’ll get with a high yield savings account.
If you want more flexibility, split your money into multiple CDs so you can access it a little at a time if the need arises. If you’re funding your CDs from a savings account, just be aware of the six withdrawal limit so you don’t incur any penalties for making too many transfers in a month.
You should also be aware that Ally’s 60 day interest penalty will eat into your principal if you break your CD in under 60 days, so don’t be too aggressive with this strategy. Once you hit the two month mark, you’ll be free to break the CD without any loss of principal, though you won’t have anything to show for your trouble.
At the four month mark, you’ll break even with prevailing savings account interest rates and, from that point forward, it’s all gravy… For example, using the current rate of 2.39% APY, your effective interest rate after 12 months will be just shy of 2% after deducting the early withdrawal penalty.
When interest rates eventually rise (they can’t get much lower!), you can simply break your CDs and reinvest the money at the new rates, or doing something entirely different with it.
Note that this strategy differs from a CD ladder, which involves buying CDs of varying lengths (e.g., 1 year, 2 year, 3 year, 4 year, and 5 year) and then renewing each of them into the longest term at maturity. While this is a great strategy, short term CD rates are abysmal right now, so you’ll pay a price to get the ball rolling.