Have you heard the buzz around certificates of deposit (CDs), but you’re still not quite sure what they are or how to use them? You’ve come to the right place!
We’ll explain just what a CD is, plus answer common questions, so that no matter your level of financial expertise, this tool is within reach. In the current market, CDs are likely worth your time to explore, as they can offer a safe place to store your nest egg or serve as a high-yield option to wait out high inflation rates.
What is a CD?
A certificate of deposit (CDs) is a long-term savings tool that earns interest on a lump sum over a fixed period of time. Sounds like a savings account, right?
A certificate of deposit is a type of savings account, but it has some crucial differences. Unlike a regular savings account, once you deposit your money into a CD, it is locked for a specific period of time, and can’t be touched without incurring fees or losing earned interest.
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What are the benefits of CDs?
The fact that you won’t be able to touch your savings for a specific period of time might seem like a disadvantage at first, but it can have serious benefits: if you’re trying to save for something, a CD can help prevent you from taking the money out too early, and CDs usually offer healthy interest rates, allowing you to effortlessly grow your money.
Those interest rates are generally higher than most bank accounts—and they’re typically even higher if you’re willing to lock in your money for longer periods of time. In the current financial climate, CDs are an especially attractive investment for savers who want to earn more than what they would in a traditional savings account, but who don’t want to take on the risk and volatility of other types of investments, like stocks.
Frequently Asked Questions About CDs
Despite the many perks of CDs, many people are still hesitant to incorporate them into their overall financial plan. To help you make an informed decision, we’ll explore some common questions.
Is there only one kind of CD?
There are actually a variety of different types of CDs for consumers to choose from. There are basic categories that are very different from each other—for instance, fixed-rate and variable-rate CDs. There are also jumbo CDs (requiring a deposit of $100,000 or more), IRA CDs (offering many benefits of traditional or Roth IRAs), and liquid/no-penalty CDs (providing more flexibility in withdrawals). The variety of CDs available depends on the financial institution.
In general, when considering which type of CD is right for you, there are three different factors to consider:
- Term. This is the length of time that you agree to leave your funds deposited in the CD to avoid penalty fees, and to earn the full amount of potential accrued interest. The term can vary from a few months to a few years.
- Principal. This is the sum that you agree to deposit when you open the CD. This can vary drastically across financial institutions and accounts.
- Interest rate. The interest rate determines how much money your principal deposit will earn over the course of the CD term. Usually, the longer the term, the higher the interest rate. You can also choose fixed interest rate CDs, where the rate will stay the same no matter what over the course of the term, or variable interest rates, where the rate will fluctuate with the state of the market.
Do I need a lot of money to open a CD?
As mentioned above, the principal amount you choose to deposit is often a deciding factor in the type of CD you open. Unfortunately, many people mistakenly believe they need $5,000 to $100,000 to open a CD, but in fact they’re often available for as little as $500 to $1,000. Although a larger deposit will see a greater return due to the way interest accrues over the course of the term, you’ll still see growth on your deposit even if it’s on the smaller side.
Can I lose my money with CDs?
This is probably one of the biggest misconceptions when it comes to CDs. While you may lose money in investment CDs that are tied to the stock market, most CD products offered by banks and credit unions are federally insured, making them one of the most secure investment options available. Government institutions (the FDIC and the NCUA) insure vehicles valued up to $250,000. So even if you withdraw your money early and incur the resulting penalty, the penalty is typically only a small portion of the interest you’ve earned.
Is my savings or checking account a better risk-free vehicle for my money?
The idea that a savings or checking account is a better savings vehicle for you is only true if several criteria are met:
- You need frequent access to your money
- Your account service fees are minimal
- You’re somehow earning better interest rates than with CDs
The chances of earning a higher interest rate with a savings or checking account is unlikely. If you can separate a portion of your savings for a CD, you’ll earn a higher interest rate and be less tempted to spend it.
Do I have to lock away my money for a long time?
Most credit unions and banks offer CD terms as short as six months, but if any term length makes you uncomfortable, you may want to consider putting your savings into a money market account instead. Many buyers strike a compromise to keep part of their money liquid, i.e. CD laddering—a method of buying multiple CDs with staggered maturity dates—so they have frequent opportunities to remove their money (or reinvest it) as needed.
Consider CDs as Part of Your Total Financial Plan
As you can see, CDs can be a great option if you want a low-risk investment that will help you save for the future. By setting aside money in a CD, you can usually earn a higher rate of return than a traditional savings or checking account, while knowing that your investment is federally insured and therefore more or less completely safe.
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