When the Federal Reserve cut the federal funds rate in September 2024, the cut kicked off what many investors believe will be a period of falling interest rates. At a high level, this means borrowing costs (like the rate you pay on credit card debt or a mortgage) are likely to fall, but the interest you earn in a savings account will probably decrease over time, too. Understandably, you might be wondering if there’s anything you can do to keep earning a higher rate on your savings.

Certificates of deposit, or CDs, are one popular way to try to earn more interest than you otherwise might in a savings account. A CD is a savings certificate with a fixed maturity date and a specified, fixed interest rate that is typically higher than what you’ll get from a savings account. CDs are generally issued by commercial banks and FDIC insured up to $250,000. Because the interest rate on CDs is fixed at purchase, they can be attractive when interest rates are expected to fall because it’s possible to “lock in” the rate when you buy the CD and keep earning that rate until maturity, even if interest rates fall further during that time. But CDs aren’t the only option.

Wealthfront doesn’t offer a CD, but we do offer an Automated Bond Ladder—a product with many of the same benefits as CDs and a few key advantages. Our Automated Bond Ladder is a portfolio of US Treasuries with staggered maturities (commonly called a “bond ladder”), making it a low risk investment option designed to provide a steady yield with no state income taxes. It is also SIPC protected up to $500,000. Like a CD, it allows you to “lock in” an interest rate for your cash, which can be beneficial if you expect interest rates to fall. 

In this post, we’ll explain why if you’re interested in a CD, you might actually prefer an Automated Bond Ladder. 

Liquidity and penalties

Liquidity matters: Money you’ve saved for your goals isn’t so helpful if you can’t access it when you need it without paying a penalty. And in many cases, an Automated Bond Ladder will offer more liquidity than a CD. 

The process of getting started with a CD and an Automated Bond Ladder is similar in that, in each case, you’ll have to decide how long you’ll want to leave your money invested. When you open a CD, you’ll choose what’s known as the “maturity” or “term length.” This could be several months up to several years, and it’s the period of time you’re generally expected to leave the funds deposited within the CD. Similarly, when you open an Automated Bond Ladder, you’ll pick your maximum maturity, which can be anything from three months to six years. Choosing a greater maximum maturity means you effectively “lock in” your yield for longer (which can be good if you expect interest rates to decrease).

But what if you pick a term length or maximum maturity that is too long, and you actually need your money sooner? This is where one of the key differences between CDs and an Automated Bond Ladder comes in. Many CDs will charge a penalty if you withdraw your funds before maturity (often 3-12 months’ worth of interest), which can eat into your total interest earned and even your principal in some cases. Wealthfront’s Automated Bond Ladder, on the other hand, charges no penalties even if you sell before the Treasuries in your ladder mature. It’s worth noting that you’ll take on a small amount of risk to your principal if you withdraw from your Automated Bond Ladder before maturity, but you could also come out ahead—it all depends on whether bond prices have gone up or down since you bought yours.

After-tax returns

When you’re comparing CDs and an Automated Bond Ladder, it’s important to understand the differences in how their interest is taxed. Depending on your situation, these differences can be significant. 

The interest you earn from a CD is taxed as ordinary income at both the state and federal levels, much like the salary you earn at your job and the interest from a high-yield savings account or Wealthfront Cash Account. Automated Bond Ladders, however, are made up of US Treasuries—bonds whose interest is exempt from state taxes.

This means that even if interest rates for CDs and an Automated Bond Ladder are fairly similar, you are likely to come out ahead with an Automated Bond Ladder because you can keep more of any potential earnings, assuming you live in a state with income tax. The higher your state taxes, the more advantageous these tax benefits are likely to be for you personally. Wealthfront built a calculator to help you understand how much you personally could benefit from these tax benefits.

Callability

Finally, to understand the differences between a CD and an Automated Bond Ladder, it’s important to know about callability. 

Picture this: You’ve deposited money you don’t expect to need for five years into a five-year CD. Interest rates have declined, so you’re feeling pretty good about the rate you locked in. Or at least you thought you locked it in… until your bank contacts you to say they’re calling your CD, and you won’t be earning that interest rate for five years after all.

Some CDs are callable, meaning the bank that issued them can essentially back out early. If you were counting on earning that CD’s yield for a set period of time, this can be a pretty frustrating experience. Wealthfront’s Automated Bond Ladder, on the other hand, is made up with US Treasuries which are not callable. So with an Automated Bond Ladder, you don’t have to worry about this particular possibility. 

Key takeaways

Both CDs and an Automated Bond Ladder can be attractive to investors looking to earn more on their excess cash. But the Automated Bond Ladder has a few key advantages over CDs:

  • Wealthfront’s Automated Bond Ladder does not charge early withdrawal penalties, unlike some CDs 
  • Interest earned from an Automated Bond Ladder is exempt from state taxes, unlike interest from CDs
  • The US Treasuries that make up an Automated Bond Ladder are not callable, whereas some CDs are callable

We hope this helps! 

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Disclosure

The information contained in this communication is provided for general informational purposes only, and should not be construed as investment or tax advice. Nothing in this communication should be construed as a solicitation, offer or recommendation to buy or sell any security. Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Wealthfront Corporation (“Wealthfront”) or any affiliate endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.

All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future success. Securities investments are not bank deposits, are not bank guaranteed or FDIC-insured, and may lose value. Please see our Full Disclosure for important details.

Investing in US Treasuries involves risks, including but not limited to interest rate risk, credit risk, and market risk. While US Treasuries are considered to be among the safest investments, they are not entirely risk-free, and there is a potential for loss of principal. Returns on US Treasuries can also be affected by changes in the credit rating of the US government, although such occurrences are rare. Investors should consider their tolerance for these risks and their overall investment objectives before investing in US Treasuries. Past performance does not guarantee future success.

The yield earned from US Treasuries is exempt from state and local income taxes. However, interest income from Treasuries is subject to federal income tax. Tax treatment may vary depending on your individual circumstances. To understand implications for your specific financial situation, please consult with a tax professional.

Neither Wealthfront nor any of its affiliates guarantees the performance of the Automated Bond Ladder or any other investment product. Returns are subject to market fluctuations and cannot be predicted or guaranteed.

The Cash Account is offered by Wealthfront Brokerage LLC (“Wealthfront Brokerage”), a Member of FINRA/SIPC. Neither Wealthfront Brokerage nor any of its affiliates are a bank, and the Cash Account is not a checking or savings account. We convey funds to partner banks who accept and maintain deposits, provide the interest rate for the cash deposits in the Cash Account, and provide Federal Deposit Insurance Corporation (FDIC) insurance. Deposits held at partner banks are not protected by SIPC. Investment management and advisory services–which are not FDIC insured–are provided by Wealthfront Advisers LLC (“Wealthfront Advisers”), an SEC-registered investment adviser, and financial planning tools are provided by Wealthfront Software LLC (“Wealthfront Software”).

The Automated Bond Ladder offered by Wealthfront is covered by SIPC up to $500,000 per account, including a $250,000 limit for cash. SIPC protection is limited to the loss of cash and securities held at a financially troubled SIPC-member brokerage firm and does not protect against market fluctuations or declines in the value of securities.

Certificates of Deposit (CDs) are generally FDIC-insured up to $250,000 per depositor, per insured bank, for each account ownership category. FDIC insurance only applies to deposits held at FDIC-member banks and does not cover losses resulting from market fluctuations or changes in interest rates.

The comparison between CDs and the Automated Bond Ladder is based on general features of these products. Individual product terms and conditions may vary and one product may be better suited than the other. Each client should consider their individual circumstance and consult with a tax professional and/or a personal financial adviser to determine which product better suits their needs. The benefits of locking in an interest rate with a CD or an Automated Bond Ladder depend on interest rate trends and market conditions, which cannot be predicted with certainty.

The Automated Bond Ladder does not impose early withdrawal penalties; however, selling bonds before maturity may result in a loss of principal if market conditions have changed. Early withdrawal penalties for CDs vary by issuer and term. Penalties may reduce the interest earned and, in some cases, the principal. Clients should carefully review the terms of any CD before investing.

The calculator tool offers a hypothetical estimate of the after-tax, after-fee yield of a U.S. Treasury ladder and its corresponding tax equivalent yield (TEY). Both calculations are based on methodology described more fully below and in our White Paper. The tool is designed as an additional resource to users who wish to evaluate return characteristics of specific investment choices. The tool requires users’ inputs. Desired length is used to illustrate average yield. State of residence, annual pre-tax income, and tax filing status are used to infer marginal federal and state tax rates based on the latest tax bracket information and calculate TEY. The tool is not intended as tax advice, and results may vary. Clients should consult a qualified tax professional to understand their specific tax situation.

Wealthfront Software, Wealthfront Advisers, and Wealthfront Brokerage are wholly owned subsidiaries of Wealthfront Corporation.

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About the author(s)

Alex Michalka, Ph.D, has led Wealthfront’s investment research team since 2019. Prior to Wealthfront, Alex held quantitative research positions at AQR Capital Management and The Climate Corporation. Alex holds a B.A. in Applied Mathematics from the University of California, Berkeley, and a Ph.D. in Operations Research from Columbia University.