Banks and credit unions offer certificates of deposit (CDs), which are among the safest investments available. They usually pay higher interest rates than savings and money market accounts, but there is a catch: you must lock your money in the account for a set period. It is possible to get it out sooner, but you will almost certainly be charged a penalty.
What is the Function of a CD?
A "time deposit" is a type of CD. You agree to keep your money in the bank for a set period in exchange for a higher interest rate. In exchange for that agreement, the bank agrees to pay you more interest than you would get from a savings account. Because the bank knows it can use your money for longer-term investments like loans, and you won't ask for it next week, you'll get a higher annual percentage yield (APY) on the funds you deposit. When you open a CD, you can keep your funds locked up for as long as you want. The term refers to the time in question. CDs are available in a variety of formats, and banks and credit unions are constantly adding new ones. CDs used to have fixed rates that didn't change, and you had to pay the penalty if you cashed them out early. But that isn't always the case anymore.How to Get Started with CDs
Contact your bank or credit union if you want to open a CD with a local financial institution. Most banks will walk you through your options and allow you to invest in CDs online. You can also speak with a banker in person or call customer service. Tell them how much you want to invest and inquire about early withdrawal penalties and other CD options. There may be other CD options available at the bank that are a better fit for you. They could provide better rates, more flexibility, or other benefits. After you put money into a CD, your statements or online dashboard will show a new account. CDs can be held in nearly any type of account, including IRAs, joint accounts, trusts, and custodial accounts. Stick to CDs that are insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Don't be afraid to ask your bank or credit union for a better rate, especially if you do a lot of business with them.CDs are divided into several categories
CDs with Liquid or No Penalty
Liquid CDs allow you to take your money out early without incurring penalties. This flexibility allows you to move your money to a higher-paying CD if the need arises, but it comes at a cost. Liquid CDs may offer lower interest rates than CDs that are locked in for a set period of time. It makes sense if you think about it from the bank's perspective. They're taking the risk of interest rate hikes. Still, if you can switch to a higher rate later—and you're confident rates will rise soon—earning less for a short time might be worth it. If you're considering buying a liquid CD, make sure you're aware of any restrictions. You may be restricted in terms of when you can withdraw funds and how much you can withdraw at any given time. You may also be required to put down a larger deposit than other CDs.CDs that have been bumped
Bump-up CDs offer a similar benefit to liquid CDs. You will not be stuck with a low return if interest rates rise after you purchase one. You can keep your current CD account and switch to the new, higher rate offered by your bank. Important: You may need to notify your bank ahead of time if you want to use your bump-up option. If you don't do anything, the bank assumes you'll stick with the current rate. You also don't get an unlimited number of bumps. Bump-up CDs, like liquid CDs, often begin with lower interest rates than standard CDs. If rates rise sufficiently, you may gain an advantage, but if rates remain stable or fall, you would be better off with a standard CD.CDs for filling in the gaps
You're not locked into the rate that was in place when you bought your CD because these have regularly scheduled interest rate increases. Every six or seven months, there could be an increase.CDs exchanged
CDs purchased through a brokerage account are referred to as "brokeraged CDs." Rather than opening an account at a bank and using their CD selection, you can buy brokered CDs from various issuers and keep them all in one place. This gives you more flexibility, but brokered CDs carry additional risks. Check to see if the FDIC insures any issuer you're thinking about. CDs that aren't insured, predictably, will cost you more. It can also be difficult to get out of a brokered CD early.CDs in jumbo sizes
As the name implies, Jumbo CDs have extremely high minimum balance requirements, typically in excess of $100,000. It's a safe place to keep a large sum of money because up to $250,000 of it is FDIC-insured, and you'll get a much better interest rate.Dates of Maturity
When your CDs reach the end of their term, you'll have to decide what to do with them. As the deadline approaches, your bank will notify you and provide you with several options. If you do nothing, your money will be re-invested in another CD, and your CD will be automatically renewed. If you were on a six-month CD, it would be rolled over into another six-month CD. It's possible that the interest rate will be higher or lower than what you were earning before. If you want to do something other than roll your money into a new CD, let your bank know before the renewal deadline. You can transfer the funds to a checking or savings account or switch to a different CD with a longer or shorter term.Constructing a CD Ladder
Consider a ladder, a standard CD investing strategy, if you want to use CDs as a key part of your savings plan. Buying several CDs with different terms so they mature at regular intervals is the first step, followed by re-investing the money into longer-term CDs as the first ones mature. For example, if you want to save $5,000, you can put $1,000 on each of five CDs with one-year maturity dates. When the 1-year CD matures, you'll transfer the funds to a new five-year CD, which will mature the following year after the first five-year CD. Because a CD matures every year, you could repeat this process indefinitely until you need the money. Tip: By using ladders, you can avoid locking up all of your funds in a meagre CD and incurring early withdrawal fees.Savings Accounts vs. CDs: What's the Difference?
Putting it on a CD could be the perfect solution if you have a large sum of money in a traditional savings account and are confident that you won't need it for a while. It is almost certain that you will be able to earn more interest on that money as a result of it. You could potentially double the amount of interest you earn depending on how long you want to tie up your money and the size of your deposit. Tip: If the money in your savings account is set aside as an emergency fund in case you lose your job or become ill, you may want to leave it alone. Perhaps you could open a new saving account to invest the funds in a CD later. Make sure the money you're putting into CDs isn't money you'll need in an emergency. Taking out a loan to cover an emergency will almost certainly cost you far more in interest than a CD would ever pay you.CDs have several advantages.
Consider your specific needs before deciding whether or not to invest in a CD. The following are some of the benefits of purchasing a CD: Your funds are protected: CDs are insured by the FDIC for up to $250,000. You will never lose your principal, according to the federal government. As a result, they pose a lower risk than bonds, stocks, or other volatile investments. Better rates than checking and savings accounts: CDs typically pay a higher interest rate than checking and savings accounts that pay interest. They also pay a higher rate of interest than other safe investments like money market accounts and money market funds. You can look around for the best rates by comparing prices. Because they are short on cash, small banks will offer better rates. Because their costs are lower, online-only banks will be able to offer higher rates than traditional banks. Furthermore, if you deposit a large sum of money in the form of jumbo CDs, you will almost certainly receive higher-than-average rates.CDs have a number of drawbacks
CDs aren't for everyone, and they might not be the best option for you. The following are some of the reasons to stay away: The main disadvantage is that your funds are locked up for the duration of the certificate. You will be charged a penalty if you need to withdraw your money before the term is up. However, there are several types of CDs that offer some flexibility, so don't forget to inquire about your options with your bank. Interest rates may rise: There's a chance that interest rates on other products will rise during your term. You can get a no-penalty CD if interest rates appear to be rising. After the first six days, you can get your money back without charge at any time. They pay more than a money market account but less than a regular certificate of deposit. CDs do not pay enough to keep up with the inflation rate, so APYs lag. If you only invest in CDs, your standard of living will deteriorate over time. Stock investing is the best way to stay ahead of inflation, but it is risky. It's possible that you'll lose your entire investment. Treasury Inflation-Protected Securities or I-Bonds could provide a slightly higher return without risking your money. Their disadvantage is that if there is deflation, you will lose money.Most Commonly Asked Questions (FAQs)
Why are certificates of deposit more attractive than money market accounts in terms of interest rates?
Because money market accounts are more liquid than certificates of deposit, CD investors are compensated more for their inconvenience. Money market account holders have more opportunities to transfer funds in and out of their accounts, so there is less opportunity risk and thus less reward in the form of interest rates.What is the safety of deposit certificates?
As long as they're FDIC-insured, certificates of deposit are perfectly safe. Your principal investment is safe if a CD is FDIC-insured, even if the entity that issued the CD defaults. You won't have those same protections if the CD isn't FDIC-insured.