Certificates of deposit, or CDs, are popular federally insured savings accounts that traditionally have higher rates than standard savings accounts. With a certificate of deposit, you agree to allow the financial institution to hold your money for a fixed period, typically 3 months to 5 years. In return, the institution will pay you interest on the balance. The longer you allow the financial institution to hold your money, the higher the interest amount earned.
Financial institutions use CDs to acquire cash, which they later use to make loans available to individuals and businesses, hold in reserves, or spend on their operations. They may also use other alternative funding sources, such as the Federal Reserve Bank and other banks. These alternatives can determine the interest rate a financial institution sets on a CD.
There are advantages and disadvantages to investing your money in a CD versus alternative investments. Read more below to learn about these alternative investments.
Advantages of a CD:
- Better interest rates than regular savings accounts. Since the financial institution that issues the CD knows your money will not be withdrawn for a specific period, it can offer you a higher interest rate than it pays on its regular savings accounts.
- Security. CDs are FDIC-insured, making them a low-risk investment.
- Easy to obtain. You can walk into almost any bank or credit union and buy them over the counter. The minimum investment amount and interest rates offered vary by institution, so you may want to do your homework.
- Wide selection. There are many types of CDs available with various terms and maturities to fit your specific needs.
- Fixed return. Financial planning is easier when you know that your investment will grow at a specific pace over time, regardless of the changing economy.
Disadvantages of a CD:
- Limited liquidity. Once your money is placed into the CD, it stays there for the entire term. Should an emergency arise requiring you to withdraw money from a CD, a penalty will apply. The result can mean sacrificing interest or losing principal.
- Low returns. While CDs are low risk, they are also low yield, lagging returns on other investment products like stocks and bonds.
- Inflation risk. If your rate lags behind inflation over the term of your CD, you risk losing your money's purchasing power over time as interest gains are overtaken by inflation.
Whichever type of CD you choose, you can be confident that your investment will be safe and that the return will generally have a guaranteed rate for the term. The guiding principles for any investor in a CD are to determine how much cash they can invest and how long they can wait before needing it back. CDs offer a safer alternative to the stock market and a higher rate than a savings account, which makes them very appealing to many investors.
If you want to know if a certificate of deposit is the right savings solution for you, give the experts at NASB a call at 800-677-6272 or click here for more information.
