When most people hear about CDs, they start wondering why anyone would still buy them in a world where music has gone digital. However, the financially savvy can usually tell within a few words of the conversation if the term CD is being used as a shorthand for certificate of deposit. These kinds of CDs are typically used by investors who want a greater reward than they’d get with a savings account, but which offers a great deal less risk than the stock market and other less stable investments.
How Certificates of Deposit Work
A certificate of deposit is, in many ways, just like a savings account. You earn interest on the amount of money you deposited, and it is protected by the federal government. The amount used to be up to $100,000, but is typically $250,000 today. What makes a CD different from a savings account is the amount of interest it generates, if not the type of interest. A CD has a higher interest rate than a savings account, and it earns compound interest, which takes funds already earned into account when calculating the next interest payment. You can view today’s highest interest rate CDs here at Banks.org.
The other big difference between a CD and a savings account is that you can typically take money out of a savings account with no penalty. That is not so with a CD. If you open a CD, you have to leave your money in it until it reaches a maturity date, which can be between a few months on up to five years. If you take money out before that maturity date, then you incur a penalty. Once a CD has matured, you have the option of withdrawing your funds freely. Or you can put some, or all, back into a new CD, and start the whole process over again. Typically an investor will toss money into a CD, and leave it there until it’s reached a certain size. Or something happens, and that investment needs to be used for a more practical purpose (paying for healthcare, covering college costs, etc.). If no emergency crops up, though, funds can be left in the CD cycle for years, growing a bit more on every deposit.
Are Certificates of Deposit a Good Investment?
The answer to this question will vary, depending on what the investor’s definition of “good” happens to be. For example, if an investor is looking for a huge return on investment, then a CD won’t be a very appealing investment due to its relatively low potential return when compared to mutual funds or the stock market. You can’t lose money with a CD as you can with shares in a public company. If an investor wants liquidity, then a CD is worse than stocks, but better than government bonds, which can take decades to mature to their full size. If security is an investor’s major concern, then a CD is quite a solid investment because of the FDIC insurance.
There’s always a balance to maintain, and that balance will change depending on who is investing. For instance, someone with a big portfolio and a great deal of money has the luxury of spreading out investments, and taking a few risks. Someone who just received an inheritance, and is still working an extremely modest day job to make ends meet, doesn’t have the same luxury. However, anyone who has money saved up can put that money to work. As long as, that is, there isn’t a big risk that the funds will need to be liquidated and put to work in a big hurry. If it’s tied up in investments, that can come with a particularly harsh bite when the investor has to withdraw.
It all depends on what the investor wants, which is the key to remember any time someone is investing.