Certificate of Deposit Pros and Cons, 5 Things to Know
The Pros and Cons of Certificates of Deposit.
Are you looking for a safe and reliable way to invest your money? If the financial industry was a viral video platform, then you might notice that CDs or Certificates of Deposit were trending. CDs are a popular investment choice that offers guaranteed returns with little risk. Many people feel safer investing in CDs in turbulent times and with rising interest rates of late, they are becoming more attractive. In this blog post, we'll explore everything you need to know about investing in Certificates of Deposit and help you decide if they're the right investment option for you.
1: What is a Certificate of Deposit (CD)?
A certificate of deposit, or CD, is a type of savings account that typically offers a higher interest rate than a traditional savings account. CDs are FDIC-insured to a limit and offer a fixed interest rate for a set period of time, which can range from a few months to several years.
The tradeoff with a CD is that you lock away your funds for the length of the term, and will get a penalty for ending the CD early. This allows the bank to feel a little safer knowing you won’t transfer it out in a month, and they offer a larger return in exchange. CDs are a low-risk investment option, which makes them ideal for those who are risk-averse or looking to preserve their capital.
CDs are particularly valuable if you know that you will not need access to your funds for a set period of time. You will also want to make sure you have a well-stocked emergency fund that is accessible in a savings account so you do not have to break your CD term in an emergency. If you need help saving an emergency fund first, then check out my article on sticking to a budget. Let’s review the certificate of deposit pros and cons.
2: Certificate of Deposit Pros and Cons
Pros of investing in CDs
There are many options when it comes to investing. Including stocks, bonds, mutual funds, etc. Sometimes we may overlook the Certificate of Deposit because they seem out of date, but with rising returns on CDs lately, they are standing out as a safe way to earn dividends with low risk.
Cds are a safe investment. Your money is FDIC-insured up to $250,000, and while we have certainly all been shocked to witness a bank run in March of 2023, the Federal Government still stepped in to insure over $250,000 to make depositors whole. You should, however, still only count on the $250,000 per person or $500,000 per couple across all your accounts at an institution.
CDs also offer a higher interest rate than traditional savings accounts. This means you can grow your money faster with a CD than with a savings account. Finally, you may want to also look into CDs with special terms. Many banks or credit unions will offer specials to entice you to lock some of your money away in a CD, so make sure you talk with a personal banker to get the best rate.
Cons of Investing in CDs
The main drawback of a CD is that you lose immediate accessibility to the funds. You need to make sure you have a healthy emergency fund, because if you need to withdraw these funds in a crisis - you may be waiting a few business days.
Early withdrawal typically also comes with a penalty, and you may lose some of your accrued earnings. So, if you know you are going to need to break the CD early, then you are better off saving yourself the hassle and keeping it in a high-yield savings account.
While we also live in a time of high inflation, know that your CDs may or may not keep up with inflation. The Fed is still raising rates to try and stifle inflation, so it may be possible for your CD to outpace inflation, but only if they are successful in taming the rate of inflation.
One downside of CDs is that you may take one out too early, only to see that the CD rates in a few months are much higher. I typically recommend people keep their funds in high-yield savings accounts or money markets until they think the CD rates have peaked and then lock the money into a CD while rates fall. This can be tricky if you haven’t eavesdropped in the financial district lately. Luckily, I do write about it more in this article comparing different savings account types.
3: When to Invest in Certificates of Deposit
Knowing when to invest can be tricky. Follow this checklist before setting up your next CD.
Do you need a guaranteed return with low risk?
Are you saving for a specific long-term goal?
Are you certain that you will not need these funds next month if your car breaks down?
Are you sure that you don’t want to pursue a riskier investment with the potential for higher returns?
4: Calculating the Rate of Return on a CD
When investing in CDs the calculation is pretty straightforward. Your interest is guaranteed at a set rate, and they typically vest dividends quarterly. You will want to find the annual percentage yield (APY) of the CD. This is a common number in financial products so you can easily compare the earning rate to other products.
To calculate how much you would earn on a CD, you can do this simple calculation once you know the amount to invest, the APY, and the term. Let’s say you are investing $1000 at 4% for a year.
The simplified calculation for us smooth brains would go like a $1000 investment *.04 (4%) = $40.
This calculation leaves out the compounding schedule, which if it was compounding quarterly would net you an extra 60 cents. Check out this calculator to play around with more in-depth cases.
5: How to Open a CD Account
Cds can be opened at banks or credit unions. You can look online to see if you can find higher yields than offered at your local institutions. With the slow modernization of the financial industry, you may be able to accomplish this online. However, having a personal relationship with a banker is important to many people. If you prefer to open one in person, then visit your primary financial and set up an appointment.
Typically, if you do nothing your CD will roll over into the same term. Before it does, you should consider if you want to sign up for another special if they have one available. So, set a calendar reminder to decide if you want to renew the CD or cash it out.
Opening a CD account is a simple process and can be a great way to save money.
CDs are Not the Only Way to Invest in Yourself
Now you know about the certificate of deposit pros and cons, but there is another way to invest in yourself. I’m not talking about traditional investments. Did you know I also offer money coaching on my Patreon? Well, you made it this far, so I am going to shoot my shot. So many people have a personal trainer or therapist to check their blind spots and set goals. With my financial wellness program, you will get a monthly call to help you earn more money and learn to budget.
