Curious about investing in a Certificate of Deposit (CD)? Here’s what you need to know: A CD falls in the savings account category but is considered to be low-risk and typically offers a higher return than a regular savings account. You can obtain a CD from a bank or credit union by depositing a certain amount of money for a fixed period of time. This period can be as short as three months or up to five years. The specific date on which you can withdraw your money is referred to as the CD maturity date.
Tip: Usually the longer the fixed period, the higher the interest rate = higher return!
A few other important things to know are:
- Money can only be deposited into the account at the beginning of the period and no other contributions can be made after then.
- Your bank may require a minimum deposit amount.
- The interest rate is fixed once a CD is opened.
- The money you deposit cannot be accessed before the maturity date (end of the period) or there may be a fee for early withdrawal. These penalty fees do vary in cost and are dependent on the length of the CD period and individual bank policies.
Advantages of CD Investments
Using a Certificate of Deposit (CD) for savings has several advantages. First, it’s super safe because your money is insured by the government, so even if the bank goes bankrupt, you’re covered up to $250,000. Second, CDs guarantee your returns; you know exactly how much interest you’ll earn because rates stay fixed. For example, a 5-year CD with $5,000 at 1.00% APY grows to $5,255. CDs can also offer higher interest rates than regular or high-yield savings accounts. You can do a clever thing called CD laddering to keep your money accessible while benefiting from changing rates. Plus, no annoying monthly fees!
Types of CDs
When deciding which type of CD to get, It’s important to understand the difference between each one. There are many different options when purchasing a CD and they each offer their own advantages depending on your investment needs. Some CDs that are offered are traditional, bump-up, liquid (or no penalty), and high-yield. A traditional CD account requires a minimum deposit and has a fixed interest rate. The money stays in the account for a specified term and can’t be taken out without acquiring an early withdrawal penalty. The benefit of opening a Bump-Up CD account is that it allows you to bump up your rate if interest rates rise after you’ve already opened your account. Keep in mind that this type of account usually has a lower APY rate compared to a traditional CD. With a liquid CD account, you are allowed to withdraw money before the end of your term without an early withdrawal penalty. Depending on your bank, there is usually a minimum of at least 6 days of the account being open before you can withdraw. The APY of a liquid account will be lower than a traditional one. High-yield CDs are similar to traditional ones but have a higher yield. There is still a penalty for early withdrawal with this account. Choosing the right CD is entirely based on your personal investment goals and needs so for a more exhaustive list and greater detail on CD terms, we recommend this article by Bank Rate.
How to Invest in CDs: Step-by-Step
- To get started, you’ll need to choose a financial institution that offers CDs, deposit your funds, and select the CD type and term that aligns with your goals. It’s crucial to compare interest rates, terms, and any penalties for early withdrawal before making your decision.
- Once you’ve selected a bank or credit union, you should decide how much money you want to invest. CDs usually have minimum deposits, so be sure you can that requirement.
- Next, you’ll want to select which of the 4 types of CDs you’d like to invest in. Make sure to pick the CD that best fits your financial goals. After you’ve thoroughly chosen a bank and CD type you’ll open the CD account, make sure to read the terms and conditions before finalizing your actions.
- Lastly, you should receive a certificate that outlines your investment, including the interest rate, term, and maturity date. All you have to do now is wait, monitor, and renew or withdraw your investment.
Risks and Alternatives
Though they can be secure investments, it’s important to be aware of CDs’ limitations. In this section, we’ll explore the potential risks associated with CDs, such as penalties for early withdrawal and the impact of inflation on your returns. We’ll also briefly mention alternatives to CDs to help readers make well-informed financial decisions.
Certificates of Deposit (CDs) are a secure way to save, but they have their drawbacks. The main problem is that they may not keep up with rising prices, meaning your money’s purchasing power shrinks over time. Also, if you withdraw money from a CD before it matures, you’ll face penalties. So, what are the alternatives?
- High-yield savings accounts: These are like regular savings accounts but offer better interest rates. They’re flexible, so you can access your money when needed. The downside is that the interest rates can change.
- Money market accounts: These pay more interest than regular savings accounts and allow check writing. But, like high-yield savings accounts, they have transaction limits.
- Dividend stocks: Unlike CDs, dividend stocks pay you regularly. However, they involve stock market risks, and the value of your investment isn’t guaranteed.
- Bonds: Bonds, especially government ones, are considered safer than stocks. But there’s still some risk, especially with corporate bonds. Treasury Inflation-Protected Securities (TIPS) protect against inflation.
If you have long-term investment goals in mind, you should consider the options listed above for CDs. For instance, if you’re thinking about purchasing your first home or need advice on mortgage rates, you should take a closer look at our “First Time Home Buying” page. Keep in mind that a diversified portfolio of stocks and bonds may provide better returns over time. Just remember, timing the market can be tricky, and a steady, long-term strategy often works best. So, consider your goals and the risks involved before locking your money away in a CD.
In summary, CDs are valuable tools with great security and predictability due to their fixed rates and government insurance policies. But it’s important to keep in mind their limitations, the impact of inflation on their value, and early withdrawal fees.
To help you further your financial knowledge, we would strongly suggest continuing to delve into our “How to Start Investing” blog and the additional resources below: