Why a CD Is a Great Way to Save if You Don’t Need Quick Access to Your Cash

If you’re seeking to earn higher interest rates than you would
through a bank account and you don’t need to access to your cash
for a while, you might want to consider a certificate of deposit,
or CD. 

But what is a CD, exactly? Read on.

What Is a CD?

A certificate of deposit (CD) is an alternative to a savings or
money market account that allows you to save a set amount of funds
with a fixed withdrawal date and a fixed interest rate. 

Because you must leave the funds in the CD account untouched for
the agreed upon amount of time, you can earn higher interest rates
than you can with traditional savings or
money market account

CDs are insured by the Federal Deposit Insurance Corporation
(FDIC) up to $250,000 in the same way that savings and money market
accounts are, making CDs a low-risk investment option.

Bank with a
credit union
? Ask your branch about share certificates, which
are the credit union equivalent of CDs. These are also insured for
up to $250,000, but by the National Credit Union Administration
(NCUA) instead of the FDIC.

The length of time it takes a CD to reach maturity can vary
greatly — typically from six months to five years, though you can
technically find CDs with terms as short as a few days or as long
as a decade. In general, the longer the duration of your CD, the
higher interest it will pay out. 

However, if you must withdraw the money early, you will be
subject to fees, which also vary. Often, it totals a good chunk of
the interest you’ve earned, which defeats the purpose of the
investment.

When It Makes Sense to Open a CD

There are several pros to opening a certificate of deposit with
your bank:

  • You’ll typically earn more interest than you would with a
    savings account.
    The national average for APY for savings
    accounts at brick-and-mortar banks is just 0.09%.
    For a 60-month CD, the national average is 1.03%, though the best
    APYs for CDs currently range from 2% to 3%. However, many online
    banks now offer
    competitive APYs on savings and even checking accounts
    that are
    competitive with CD rates, but with easier access to funds.
  • CDs are a low-risk investment. While
    stocks and bonds
    usually earn you better returns, they’re
    also riskier. You assume less risk by putting some of your funds
    into a CD.
  • There’s less temptation to spend. If you are saving
    for a clear goal — like a wedding in a year or a house down
    payment in five — a CD is a great way to protect that money while
    it grows thanks to interest. Because of the withdrawal fees, you
    will be less tempted to access that money for an impulse buy that
    ultimately puts a dent in your savings goals.

Opening a CD makes sense when you are free of credit card debt
and already have an
emergency fund
built up in your savings. Because the interest
rate of
credit card debt
is higher than what you’d earn through a CD,
it makes sense to pay off that debt first before opening a CD.

Debt-free and ready for an emergency with a healthy savings
account? A CD might be right then. But remember: Diversifying your
money tends to yield the best results.

Pro Tip

Because you’ll pay a fee if you withdraw money early from a
CD, aim to save three to six months of expenses in a high-yield
savings account before opening a CD.

The Disadvantages of CDs

CDs are not without their downsides. Disadvantages include:

  • CDs require you to freeze your money for a set amount of
    time, often years.
    If an emergency comes up and you need that
    money, you will pay a penalty to access it. 
  • They earn low returns compared with stocks and
    bonds. 
  • The interest rate is fixed. That means if interest rates
    go up on CDs at your bank, you can’t take advantage of the new,
    higher rate, which is especially frustrating with longer-term CDs.
    A good solution for that is called the
    CD ladder
    ; more on that below.

How to Optimize Your Investment With a CD Ladder

Because long-term CDs offer higher interest rates, five-year CDs
are attractive to savers. However, forking over your cash for five
years can be difficult, especially if the minimum deposit is large
or you expect interest rates to go up. 

Instead, you can split your deposit amount into fifths and open
five CDs: a one-year, two-year, three-year, four-year and five-year
CD.

When the one-year CD matures, you can pocket the interest and
invest the initial amount in a five-year CD. A year later, the
two-year CD will mature, and you can do the same. Eventually, you
will have five five-year CDs with one maturing each year. 

This makes funds more available to you on an annual basis but
achieves the overall higher interest rate of a five-year CD versus
a one-year CD.

Other Types of CDs

Generally, banks offer CDs at a fixed rate and for a fixed
duration. However, you may encounter special types of CDs with
unique terms:

  • Jumbo CD: These carry a high minimum balance requirement
    (think $100,000 or more) but come with a much higher rate.
  • Step-up CD: These CDs include predictable
    interest rate increases at specified intervals throughout the term
    of the CD.
  • Bump-up CD: These CDs allow you to request a
    rate increase (though many are limited to a single rate increase
    for the duration of the CD). Having this flexibility often requires
    a higher minimum deposit and a lower interest rate.
  • Liquid CD: These CDs give you access to your
    funds without penalty. For this flexibility, the terms may include
    a higher minimum deposit and lower interest rate.

Timothy Moore leads a team of editors and graphic designers
at a market research company as his full-time gig. As a freelance
writer, he writes about personal finance, careers, education, pet
care, travel and the automotive industry. His work has been
featured on Debt.com, The Ladders, Glassdoor and The News
Wheel.

This was originally published on
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Source: FS – All-News2-Economy
Why a CD Is a Great Way to Save if You Don’t Need Quick Access to Your Cash