One of the safest investments that are available from Credit Unions and banks is the Certificate of deposit (CDs). This is because the certificate of deposit pays higher interest rates than the money market and bank savings account. The only drawback is: your money has to be locked up in the account for a specified number of months or years.
Although you can get it out before the specified period, this will most likely lead you to paying some fees as a penalty.
How does a certificate of deposit works?
A certificate of deposit is a form of “period deposit”. i.e. When your money is kept in the bank for a specified period of time, you get a higher interest rate in return. The bank will agree to paying a higher interest rate to you in return, more than you will get from a bank savings account.
A higher annual percentage yield will be received on the fund you deposited because the bank can use your money for investment for a longer period of time without you coming back and asking for it few days after it was deposited.
The length of time you want to keep your money locked up when a CD account is opened is up to you to decide. This length of time is called “term.”
Certificate of deposit comes in many forms, and the credit unions and banks continue offering new options every time. When it first arrived, the certificate of deposit came with a fixed rate, and a penalty would be paid if it’s cashed out early, but that has changed now.
How to start the use of a certificate of deposit
If you want to open a certificate of deposit account with your local financial institution, your credit unions or banks should be contacted. Most of the banks will explain the options to you and also let you make cd investments online. A banker can be spoken with in person or call your bank’s customer care line so they can explain the options to you.
Tell them how much you want to invest, what is the early withdrawal fees and also ask if there are other CD products. Your bank may have other CD options that are more perfect for you. They might offer you higher interest rates, more flexibility, or other added benefits features.
A separate account will be seen on your statement or another online dashboard when your money is moved into a certificate of deposit account.
Just make sure you stay with the CDs that are insured through the Federal Deposit Insurance Corp FDIC, or the National Credit Union Administration. Always try to ask for better rates, particularly if you do significant business with that credit union or bank.
Types of certificate of deposit (CDs)
Liquid or no-penalty CDs
This type of account allows you to withdraw your money anytime without having to pay a penalty fee. Although it comes with a price, the flexibility with this account allows you to move your money to a higher-interest paying account if the opportunity comes.
If you look at it from the bank’s point of view, it makes sense if liquid CDs are paying lower interest rates than the CDs you are stuck with. This is because are the one taking on the risk of increasing interest rates. So, earning lower interest rates for a short period is better if you will be able to switch to higher rates later – and if you are very sure the interest rate will increase very soon.
If you are trying to invest in liquid CDs, make sure all the restrictions are perfectly understood. You can be limited to when you can withdraw or how much can be taken at any particular time. A higher upfront amount may also be required to be invested than with other types of CDs.
These types of accounts come with increased interest rates that are regularly scheduled, so you are not stuck with the rates you bought your CDs with. The increase may arise every 6 or 7 months.
The benefit of this type of account is similar to that of liquid CDs. This is because you are not stuck with a low interest rate if there’s an increase in interest rates after you have bought one. Your former Cd account can be kept and then switch to a new higher rate that is offered by your bank.
Your bump—up option and intention may need to be communicated to your bank in advance. This is because if you do nothing, your bank may assume you are sticking with the existing rate. And, you won’t get unlimited bump-ups.
Bump-up CDs, like liquid CDs, normally start out with lower-interest paying rates than standard CDs. If rates rise enough, you may come out ahead, but if rates drop or stay stagnant, then standard CDs would have been better.
Brokered CDs are offered in brokerage accounts. Brokered CDs can be bought through many issuers and have them all kept in one place rather than opening an account at a bank and using their CD selections. Although it comes with an added risks, but it gives you the ability to choose what you want.
Also, be sure any type of issuers you are considering are insured by the FDIC. Know that CDs that have no insurance tend to pay more. It may also be a challenge getting out early of a brokered CD.
As the name implies, jumbo CDs, required a high minimum balance, normally in excess of $100,000. His is the safest place to invest a large sum of money. This is because as much as $250, 000 of it is insured by the FDIC, and higher interest rates will also be earned.
At the end of your CD’s maturity, you’ll have to decide on what you want next. You will be notified by your bank as the maturity date draws nearer, and several options will be given by this. If nothing is done quickly, your money could be subjected to auto-renewal and re-invested into another CD. If you were in a 6-month CD before, then during the autorenewal, your money will be rolled over into another six-month CD.
You may earn higher or lower interest rates than the one you were earning previously.
CD ladder building
If you want to use the CD as a vital part of your savings plans, a CD ladder, which is a comm investing strategy, should be considered. The process involves buying many CDs with different terms so they can mature at different times and you can then reinvest the money into longer-term CDs as they mature one by one.
For instance, if you want to save $5,000, you can split them into 5 different CDs with different maturity dates, at least a year apart. So as the 1-year CD matures, you’ll then put it in a longer-term CD, say 5-years. So this will mature the year after your 5-year CD does. This process can be continued as the CDs mature each year until the money is needed at any given time of the year.
Savings account vs CDs
If you have a lump sum of money in your savings account that won’t be needed very soon, it is only ideal to put it in a CD to yield more for interest for you, than your traditional savings account will do. The amount of interest you earn could actually be doubled, depending on the amount of money you are investing and the length of time you want to invest.
If the money you have in your savings account is your emergency fund savings, set aside in case of job loss or medical bills, it is better to just leave it in your savings account. You can just open new savings account with the aim of investing money in CDs.
Make sure the money you are investing in CDs i won’t need in a short time or for unforeseen contingencies. This is because withdrawing your money immaturely will cost you more in interest than you would earn a CD.
Benefits of CDs
Your specific needs have to be considered before you decide on whether to invest in CD or not. Some of the reasons a CD could be considered are:
- Your money is insured: As said before, that the FIDC insures CDs to a tune of $250,000. This guarantees that your principal will never be lost, as said by the federal government. Due to this, Cds have fewer risks than stocks, bonds, and other volatile investments.
- Shops can be compared: Best rates can be shopped around. Better rates are offered by small banks because they need funds. Online-only banks will also offer better and higher rates than brick and mortar banks because they have lower costs. Also, higher-than-usual interest rates can be found if a sizeable amount of cash is deposited in the form of jumbo CDs.
- Better interest rates than both savings and checking accounts: Cds generally have higher interest rates than a savings account, interest-bearing checking account, and other safe investments such as money market fund or money-market accounts.
Certificate of deposit disadvantages
CDs may not fit your specific need because they aren’t for everyone. Some of the reason to avoid CDs are:
- Interest rates could rise: The risk of interest rates going up on other products during your term is possible. You can get a no-penalty CD if it looks like interest rates are rising. This will enable you to get your money back without being charged, any time after the first six days. Although they pay less than a regular CD, more than a money market.
- Early withdrawal fees: One of the main disadvantages of CDs is that your money is stuck or tied down for the entire life span of the certificate. If you need to withdraw your money before its maturity date, then you have to pay a penalty fee. However, several types of CDs provide a certain amount of flexibility, so al ask your bank about the available options.
- APYs lag behind inflation: CDs don’t normally pay enough to keep up with the rate of inflation. Your standard of living will be lost over time if CDs are the only things you are investing on. The best way to keep ahead of inflation is to invest in stocks, but that is too risky, all your investments could be lost before you know it. A slightly higher return without risk could be gotten with Treasury inflation-protected securities or i-bonds. But your money will be lost if there is deflation.