Certificate of Deposit
It’s always a good feeling when you are sitting on a chunk of cash. It’s even better when the only decision you have to make is where to put it for safekeeping. If you are looking for a guaranteed return on your money as well as the guaranteed return of your money, you can quickly narrow your options. A savings account is a good option. But, if you’re looking to squeeze a little bit more interest on your money, your best choice may be a certificate of deposit (CD). Many savers favor CDs as a safe haven for their money where they can earn a predictable rate of return with peace-of-mind.
How does a CD work?
When you invest in a CD, you agree to deposit money with a bank for a specific period of time or term. The term can be as short as three months and as long as five years. The bank uses your money to offer mortgages and other loans to its customers and rewards you for your deposit by paying you a fixed rate of interest. The longer the term you select, the higher the rate of interest the bank is willing to pay you. You get the satisfaction of knowing your money is working harder for you than if you deposited it in a checking or savings account. You also have the peace-of-mind knowing your money will be there for you when the CD term ends. When the CD matures at the end of its term, you receive your original deposit back along with the interest that you have earned.
It’s important to note that CDs are not liquid assets. While there are some CDs that allow access to the accrued interest, most don’t allow any access to funds until the end of their term. If you try to withdraw funds before the end of the term, you could be charged a penalty and other fees. Before depositing your money, it would be important to ask about the early withdrawal penalty. If you’re not sure whether you might need access to some of your money before the end of the term, you could choose a CD with a shorter term.
Competitive rates, flexibility, safety, and access have always been the hallmark of bank CDs and, compared with many of the alternatives available for your safe money, they still hold several advantages.
One of the more attractive features of a CD is the protection of FDIC insurance for bank deposits. The FDIC (Federal Deposit Insurance Corporation), which is an agency of the federal government, provides up to $250,000 of coverage per account per bank. For the ultimate peace-of-mind, any amount over that should be deposited under a different account name or at a different bank.
When compared with other fixed yield instruments, the rates on bank CDs are very competitive, usually exceeding those of Treasury Bills, money market funds, and savings accounts. CD rates are tied to the maturity period, with longer maturities offering higher rates. Some banks may also offer higher rates on larger deposits.
With the availability of a range of maturities, depositors can balance their need for liquidity and better yields. A popular strategy used by depositors to remain flexible in anticipation of rising interest rates is to “ladder” their CDs through a combination of maturities. The net effect of the strategy is the ability to capture higher interest rates as the CDs mature while always staying invested. It also, provides a degree of liquidity because, with a laddering strategy, you will have CDs maturing each year.
For example: You could invest equal amounts in a 1-year, a 2-year, and a 3-year CD. When the 1-year CD matures, it is rolled into a new 3-year CD. After the 2-year CD matures and is rolled into another 3-year CD, you will then have a 3-year CD maturing every year that follows. Longer term laddering strategies might use 5-year CDs which can boost your average yield even higher.
Best Uses of a CD
CDs are a great option for anyone looking for a safe haven for the money for a certain period of time. Many people use CDs while they figure out what they want to do with their money over the long-term. Their best use is for saving for shorter term goals, such buying a car or a house or savings for a child’s college education, when the time frame is less than 10 years. Investors often use CDs to round out their asset allocation strategy, which might include cash or cash equivalents in addition to stocks and bonds.
For many people, the best use of CDs is when they don’t want to worry about their money. They can get the predictability and peace-of-mind they need without sacrificing the yield they need to make their money work for them.