You might consider investing in a certificate of deposit if you want to invest some money without taking much risk. But exactly what is a certificate of deposit? A CD is a bank product in which you invest your money for a set period of time at a fixed interest rate. Most banks have a CD minimum deposit amount that can vary from bank to bank and product to product. But before you invest in this type of account, understand all the advantages and disadvantages to CDs, and review all your options to find the best CDs available.
CD Interest Rates Are Higher Than Savings Account Rates
CD interest rates are usually higher than the interest earned on a traditional savings account. The CD will require you to invest for a set period of time. Generally, the longer the CD term, the higher the interest rate the bank will offer. The interest rate can be paid at the end of the CD or at regular intervals during the term of the CD.
They’re Low-Risk Investments With FDIC Insurance
CDs are considered a low-risk investment, especially when the investment is made at a bank or credit union. Bank CDs have FDIC insurance up to $250,000. This means that if the bank fails, the money is guaranteed by the FDIC and you won’t lose the money you invested. Note that the insured amount includes all of the accounts that you have in your name at the bank.
You Can Build on Interest With a CD Ladder
When you build a CD ladder, you invest in a group of CDs that mature at different times, which gives you regular access to some of your money without penalty, while the rest continues to earn interest. You can set up CDs so that at least one matures each year, or you can set them up to mature quarterly. For example, you might invest in a one-year and two-year CD. When the one year CD matures you can cash it out, then access the second CD in another year.
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You Can Capitalize on Fixed Interest Rates When the Market Drops
Fixed CD interest rates are locked in for the term of the CD. So even if the market drops, you’re still getting the same interest for the entire term of the CD. If you’re concerned about the market dropping or if you’re getting close to retirement and want a more conservative investment, a CD is a better option for you.
They Offer the Most Predictable Return From Financial Products
CDs offer a predictable return when you invest in them. Because the rate is locked in, you can find out how much you’ll earn on the CD each month or year. If you have the interest deposited into your checking account each month or annually, you can budget for that amount to cover expenses.
You Might Be Fined an Early Withdrawal Penalty
When you invest in a CD, you lock the money into the account for the term of the CD. The length of the CD will vary by institution. If you need to withdraw the CD before it reaches the maturity date, you could be charged an early withdrawal penalty, which might include a portion or all of the interest earned. Read the terms of your CD to determine what the early withdrawal penalty will be.
Rates Are Locked Even During Inflation
CD interest rate earnings might not keep up with higher periods of inflation. When the interest earnings don’t keep up with inflation, it means that your investment is losing its spending power during that term. When interest rates are equal to the rate of inflation, then the money keeps the same spending power. When the interest rates are higher than the rate of inflation, you’re gaining interest income from your investment.
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Lower Risk Often Means Lower Returns
Although CD rates are a safe investment, you might be limiting the rate of return on your investment. Other investments such as stocks, mutual funds and annuities might offer a higher rate of return. If your top priority is to grow an investment, CDs might not be the best option as part of your investment plan.
Time Deposit Might Limit Your Ability to Adjust Your Investment Strategy
When you invest in a CD, you’re investing for a set period of time. Banks lock in your CD for an agreed length of time and if the market goes up, you’ll be locked in at the lower interest rate. CDs limit your ability to move your money to more lucrative investments as the market improves; however, banks might make your CD callable. When CDs are callable this gives banks the opportunity to cancel the CD if the rates drop too low. You’ll still receive the amount you earned, but you might have to reinvest in a CD with a lower interest rate.
CD Interest Rates Might Not Rise as the Market Rises
Most CDs will offer just one interest rate for the term, however, some might offer variable CD rates. These rates can adjust up or down depending on the term of the CD. For example, the CD rate might go down as the market goes up. Read the terms of the CD investment agreement to learn how the rate of return might be affected if you’ve invested in a variable-rate CD.
Keep Reading: Here’s How Often CD Rates Change