When it comes to investing your hard-earned money, there are various options to choose from. Some people prefer to put their money into traditional savings accounts or high-yield savings accounts while others invest in the stock market. Another type of investment tool that comes highly recommended by financial experts is Certificates of Deposit (CDs).
CDs are essentially low-risk savings accounts that offer better interest rates than traditional savings accounts. But the question remains, are CDs worth it? Just like any investment option, there are pros and cons and we’ll help you decide whether or not they’re meant for you.
What is a CD (Certificate of Deposit)?
A certificate of deposit is a type of savings account that is offered by banks which guarantees a fixed interest rate for the duration of your investment. The term length of CDs can range from a few months to several years. Most times, the longer the term of the CD, the higher the interest rate. If you’re somebody who doesn’t like to take risks and wants a fixed return on your investment, CDs are ideal for you.
Unlike traditional savings accounts, the money deposited in a CD needs to remain untouched otherwise you risk getting a penalty or losing the interest rate. Once the term ends, you can then withdraw the initial sum along with the interest earned or invest that money into another CD. The interest rates on CDs are typically higher than those offered on savings accounts.
Types of CD’s
There are several types of CD accounts that you can choose from: standard, brokered, and specialty. Each has its own unique benefits so it’s important to know the ins and outs before choosing which one to go with. Standard CDs allow you to deposit money for a set period and earn interest over the course of its term. Terms can last anywhere between a week up to 10 years!
Specialty CDs differentiate from standard CDs because they offer more features. Some of these specialty CDs include higher interest rates for a higher deposit amount (jumbo CDs), no fees for withdrawing money before maturity (no-penalty CDs), making extra deposits during the term (add-on CDs), and even getting better interest rates during your term (bump-up CDs).
The last type of accounts, brokered CDs, generally have higher requirements than a specialty or standard CD. Most times these CDs need an initial minimum deposit of over $10,000. As its name states, these accounts are handled by a brokerage instead of a credit union or bank.
Pros and Cons of CDs
Just like any investment option, there are both pros and cons associated with opening a certificate of deposit account.
Advantages of Certificates of Deposit
Fixed Interest Rates: Investing your money in a CD is a great choice if you don’t want to take any risks. Knowing exactly how much interest you will earn, and there are no fluctuations in the interest rate. This investment tool guarantees a certain rate of return that you can rely on.
Short-term Investment: If you are looking for a short-term investment, investing in a CD might be a good idea. CD terms range from 1 month to 5 years, and you can choose the term that best suits your investment goals.
Low Risk: Most CDs are low-risk investment options because they are FDIC (Federal Deposit Insurance Corporation) insured, which means that even if the bank goes bankrupt, you will get your invested amount back with interest up to $250,000.
Flexibility: CDs offer a wide range of options, such as different term lengths, interest rate structure, and penalty for withdrawal. This flexibility allows you to select a CD that best fits your needs, such as a short-term CD for emergency funds or a long-term CD for long-term savings goals.
Disadvantages of Certificates of Deposit
Limited Liquidity: CDs are not very liquid investments. Once you invest your money you cannot withdraw it until the CD matures. Withdrawing your money before the CD matures can result in penalties. These penalties can be add up to about 3-6 months of interest, sometimes even more.
Limited Returns: Interest rates that CDs offer are usually lower than the average stock market return. If you are willing to take more risks with your investments, you might want to consider investing your money in other investment options that offer higher returns.
Inflation Risk: Inflation can reduce the value of your investment and make it less valuable than at the time of investment. Since your money is locked until maturity, it’s important to take inflation into account when investing in a CD.
How to pick the right CD?
When you’re looking to choose the right CD for your investment needs, there are several factors to consider. Take a look at the different interest rates that are available and compare them to other CD rates. This will help you decide which option will give you the most return on your investment. The next thing you should think about is the term length and how long you’re willing to tie your money up for. And finally, take into consideration what the penalties are for early withdrawals. It's crucial to understand all the terms and conditions before investing your money to avoid any unpleasant surprises.
Are Certificates of Deposit Really Worth It?
The simple answer is: it depends on your needs. If you are in a financial situation that allows you to put money aside and not touch it for a longer period of time, then they are worth it. If having cash at your disposal at all times is an essential, then there might be other investment options more suitable for you. CDs are a safe and viable option to leave your money.
When comparing them to a high yield savings account, CDs are a great alternative since the interest rates are generally higher. You should always track your money when you think about investing your hard earned dollars. Hiatus is a perfect financial app that will allow you to do so and is easy to use!