Certificates of Deposit, commonly referred to as CD’s, are a cross between an “investment” and a savings account. CD’s have federal deposit insurance up to $100,000- which is what sets it apart from the investment world, but they have much higher interest rates than the traditional savings account.
A certificate of deposit allows you to invest a specific amount of money over a specific period of time. There are certificate of deposits for as short as one year, for five years, or longer terms. The longer you keep your money in a CD, the higher the interest rate you will receive. When your time period has ended, and you cash out your certificate of deposit, you not only receive the original sum of money that you invested, but you’ll also get the interest that the money earned while invested.
While certificates of deposit are great ways to save money at high rates of interest, they’re not the best choice for people who may have to withdraw money from their CD’s before the investment period of time has been reached. You can access the money you’ve put into a CD before the time is up, however, you will either give up some of the earned interest or pay an early withdrawal penalty. Financially, it’s always better to leave money invested in a certificate of deposit, but it’s certainly a comfort to know that you could get the money out if an emergency occurred or you absolutely needed that money before the time is up.
Certificates of deposit have a variety of interest earning options that you must choose from when you deposit your money. There are fixed rate interest options, long-term CD’s, and variable rate CD’s, among others. If you’re not sure how each option affects your money, ask!
Who Should Use Certificates of Deposit?
While anyone is able to purchase and invest their money in a CD, it makes the most sense for a younger investor. Because CD’s earn more interest the longer they are taken out for, a younger investor can use CD’s to diversify their investment portfolio and maximize their earnings by taking the Certificate of Deposit for a long period of time. If an individual is rapidly approaching retirement, however, it may not be the best option for investing if he or she is going to need the money in a short period of time.
Understand Certificates of Deposit
Before you put your money into a CD, it’s important that you understand some of the most commonly used terms in relation to Certificates of Deposit.
Penalties: There are penalties for early withdrawal. Even if when you are opening a CD you have no plans for removing the money before your investment period is reached, you should definitely understand the penalties in case some unforeseen circumstances come up that require you to access the money you’ve put in your CD.
Interest: Always know whether or not the interest rate is fixed or variable, and how often the interest is paid on the money in your CD.
Maturity: There is a maturity date on every certificate of deposit, but there are so many possibilities for maturity dates that you should always be sure you know whether your CD matures in 1year or 5 or 20.
Call Features: Banks often put a “call feature” on all issued certificate of deposits. Callable CD’s mean that the bank that issued the CD can terminate it and give you the amount you invested plus any unpaid, accrued interest if interest rates fall.
CD Holdings: There is a difference between a traditional bank CD and a brokered CD. If you use brokered certificates, it’s possible that there are groups of investors that actually own small pieces of your CD. Regardless of the type of CD you choose, be sure that they have FDIC coverage up to $100,000.