I am looking at one of the "internet banks" and they have CDs for 1 year at 1% and 5 years at 2%. The early withdrawal fee for 5 year CD is 150 days of interest. Doesn't it mean that 300 days the CD's break even? In other words if I cancel my CD after at 300 days I'd pay 2% of interest I got in the last 150 days which would be the same as getting 1% for 300 days?

In that case wouldn't one always prefer to buy 5 year CD with current rates if you plan to keep it there at least 1 year?

  • 2
    In the US, Federal law requires a minimum penalty of one week's interest for premature withdrawal from a CD, but banks are free to charge more. Thus, your 1 year CD also is likely to have penalties (possibly – Dilip Sarwate Nov 10 '14 at 14:48
  • I understand that. But if you wanted to invest money for 1 year, why (as of today) would you buy 1 year CD at 1% when you are better off with 5 year CD at 2% and with 150 days penalty? – Vitalik Nov 10 '14 at 16:17

When the yields are significantly different, then as you say, it does make sense to sign up for longer-term CDs. One of the reasons that banks are giving incentives to longer-term CDs is that CD balances have been declining over the last few years (from $2.82T in 2008 to $1.64T at the end of 2013). Yes, you can withdraw early and get a higher rate, indeed some advisers are recommending exactly the strategy you describe. So, yes, most investors would always prefer a longer term CD with the current spreads. Just keep in mind that hasn't always been the case historically and is reasonably likely to change in the future.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.