When choosing a certificate of deposit (CD), one of the most important considerations is the interest rate your money will earn. Putting your savings in a CD can pay off when rates are high but what about when rates are low? Evaluating your financial needs and goals can help you decide if opening CD accounts is worth it.

What Is a CD and How Does It Work?

A CD or certificate of deposit is a time deposit account offered by banks, credit unions, and other financial institutions. CDs allow you to deposit money and earn a set amount of interest over a set period of time. This so-called maturity term can range from 28 days to 10 years or more.

When the CD matures, you can either withdraw your savings or roll the amount into a new CD. If you withdraw your money early you will pay a penalty.

There are different types of CDs you might open. For example, banks can offer:

• Standard or regular CDs
• Jumbo CD accounts
• No-penalty CDs
• Bump-up CDs
• Raise-your-rate CDs
• Step-up CDs
• Add-on CDs

Yankee CDs and brokered CDs are two less common types of CD. Yankee CDs are offered by U.S. branches of foreign banks. Brokered CDs are offered through brokerages.

CD deposits are insured by the Federal Deposit Insurance Corp. (FDIC) when held at FDIC member banks. The National Credit Union Administration (NCUA) insures CDs at member credit unions. Coverage limits are the same: $250,000 per depositor, per account ownership type, and per financial institution.

How Are CD Interest Rates Set?

A CD's rate is the interest rate you earn on your savings. When advertising CDs, banks can publish the interest rate and the annual percentage yield (APY). The APY represents the interest earned annualized over a period of one year. Most of the time, the interest rate for a CD and its APY are the same.

Banks can use a benchmark rate to set CD rates. In many cases, the rate used is the federal funds rate. This is the rate at which banks lend money to one another overnight. The Federal Reserve, also known as the Fed, is responsible for making adjustments to the federal funds rate in order to manage monetary policy in the U.S.

When the Fed raises the federal funds rate, banks and credit unions may raise rates offered on deposit accounts, including CD accounts. If the Fed cuts rates, banks often reduce rates offered on CDs and other deposit accounts. This doesn't happen instantly. The banks can take weeks to respond to a move by the Fed.

Does It Make Sense to Buy CDs When Rates Are Low?

If you're considering saving money in a CD, getting the best rate possible might be a priority. When interest rates are low, CDs can lose some of their appeal for savers, as they can offer less potential for growth overall. You may have even less incentive to park some of your money in CDs if you expect interest rates to rise in the near future.

Whether you should buy CDs or not, regardless of rates, can depend on your needs and goals. If you've maxed out your emergency fund, for example, and are saving for retirement in a 401(k) or IRA, you might have money to spare. A CD could offer a safe and secure place to keep that money until you need it and allow you to earn a little interest in the bargain.

On the other hand, if you need more flexibility with your money and want to get a higher rate, you might consider a high-yield savings account or money market account instead. These accounts can allow you to make up to six withdrawals per month and may feature more competitive rates than what CDs offer.

Combat Low Rates With CD Laddering

If you're concerned about low CD rates limiting your savings growth, you may consider building a CD ladder. A CD laddering strategy involves buying multiple CDs with different maturity terms and interest rates. This approach offers two advantages.

First, by laddering CDs with different maturity terms, you're better able to keep pace with changing interest rates. Say you open three CDS: a three-month, a six-month, and a nine-month. Two months after opening them, rates go up. You can take advantage of that by rolling the three-month CD into a new CD once it matures. Laddering can also help you to avoid early withdrawal penalties if a maturity date is always on the horizon. Once one of the CD "rungs" on your ladder matures, you can decide whether to withdraw the money or deposit it into a new CD. And again, if rates have risen since you opened the CD originally, you can capitalize on that increase.

The Bottom Line

Should you invest in CDs when rates are low? It may still be a good move if you're opening CDs to meet short-term needs. If rates rise later, you could roll the money over into a new CD to earn more interest until you're ready to spend it. When deciding where to open a CD account, take time to compare the best CD rates. Also, look at the different maturity terms and types of specialty CDs a bank may offer to find the savings option that's best for you.