Short-Term CD vs. Long-Term CD: Which Is Right for You?

If you have a bit of cash you'd like to put to work, and you're willing to do so by buying a certificate of deposit (CD) -- congratulations! We like it when people put their money to good, profitable use.

But choosing to invest in a CD is only the first step. You also need to decide on a CD term. To decide, ask yourself: What's your goal? And for how long are you willing to lock up your money? A CD term can stretch one month or five years -- or longer. The right term for you may not be the one with the best CD rate. 

We've got you covered. Read on to weigh the benefits of a short-term CD vs. long-term CD with confidence. 

What is a short-term CD?

CD terms tend to range from three months to five years, although there are shorter and longer terms on either side of that span.

A short-term CD has a term from three to 12 months. Shorter CD terms sacrifice higher interest rates (i.e. returns on investment) for greater flexibility.

What is a long-term CD?

A long-term CD is on the opposite side of the spectrum. Although some issuers have different criteria for what constitutes "long-term," the generally accepted range for this category is four or more years. They sacrifice flexibility for better returns.

How do CDs work?

A CD is a savings account offered by banks and other financial institutions. CDs have always been popular because they offer guaranteed returns. Unlike typical savings accounts, they hold a fixed amount of money for a fixed amount of time.

Standard CDs pay out at a fixed annual percentage yield (APY) when they hit maturity -- as long as you don't withdraw the funds. If you withdraw too early, you'll be hit with costly early-withdrawal penalties. Such penalties can sometimes exceed the return you would have earned if you'd kept that money in the account, netting you a loss.

Better-than-average returns

For the most part, though, investing in a CD is a commitment. In return for keeping your funds locked up, a financial institution typically offers higher APYs than other savings products. Lower-APY alternatives include savings accounts and money market accounts, which are typically more flexible than CDs.

Secure investments

A CD is considered one of the most secure financial instruments for determined savers. Most CDs are fully covered by the government's Federal Deposit Insurance Corporation (FDIC) up to $250,000 per person, per bank.

Special CDs

Over the years, variations on the traditional CD have hit the market. "Bump-up" and "step-up" CDs raise APYs when interest rates go up. Aside from this, they're more or less standard CDs.

Several providers offer CDs that carry penalty-free withdrawal options. But these usually have lower APYs than classic CDs -- it's a tradeoff.

Why are CD APYs higher than other deposit accounts?

CD APYs are higher because you're making a commitment to deposit your funds and not touch them for a specific length of time. This gives banks deeper insight into their financial futures. Banks charge early withdrawal penalties to disincentivize taking out money early. Banks pay investors higher premiums for stable and predictable behavior.

That's why CD APYs tend to rise in lockstep with term lengths. Keep that in mind when you're looking at short-term vs. long-term CD accounts.

Here's an illustration of short-term vs. long-term CD rates:

Short-term vs. long-term CD lengths

Whether a short-term CD or long-term CD is right for you depends on your financial situation. The first thing to determine is how long you're willing to stuff your money away without touching it.

Even if you opt for a CD that offers penalty-free withdrawals, taking out too much money before maturity will negate the gains you stand to make on your investment. So the term length of a short-term vs. long-term CD account should factor into your decision.

Ultimately, no matter what CD you're considering, the term you should choose largely depends on your financial security. Are you financially secure? If the answer is "very, and for the foreseeable future," you have a good reason to commit to the longest term possible. Five years is typically the maximum offered, but some institutions offer CD terms of up to 10 years.

Short-term vs. long-term CD rates

Long-term rates are usually significantly higher than short-term ones. But this doesn't mean you should automatically choose a longer term.

If we're in an environment of slowly rising rates, locking in a long-term CD could mean losing out on boosted savings. Other banking products, like money market accounts, might let you take advantage of interest rate hikes.

Invest in short-term standard CDs to combine security with flexibility. Short term means you may get funds back in time to take advantage of rate hikes by reinvesting elsewhere. You might also consider longer-term, step-up or bump-up CDs that rise alongside rate hikes.

On the flip side, you can lock in flat or shrinking rates with long-term CDs. Plus, you can take advantage of their typically higher returns. Just be sure you don't need to withdraw the money early -- that would be bad for your wallet.

You can treat CDs as part of your emergency savings. The best way to do so may be via CD laddering or continuously reinvesting in short-term CDs. For example, you could take out a 6-month CD and keep rolling it over until you need to use it to pay for an unexpected bill. The downside to this strategy is you may need to withdraw funds early and pay hefty fees. To avoid this, consider building your emergency fund in a high-yield savings account.

Still have questions?

Here are some other questions we've answered:

• CDs vs. savings accounts: Which is right for you?
• CDs vs. money market accounts: Which is right for you?
• CDs vs. bonds: What's the difference?