A great tool for earning interest on your money is a Certificate of Deposit (CD). A CD is essentially an agreement between you and your credit union or bank where you promise to not withdraw any cash within a specific period of time, and in return the credit union or bank pays you a higher rate of interest on the money used to fund the CD.
The period in which you are not allowed to withdraw any cash varies depending on the terms of the CD. The terms can be as short as three months for shorter term goals, all the way up to five years for longer term investing goals. Generally speaking, the longer the terms of a CD, the higher the interest rate will be.
Though Certificate of Deposits are considered to be a solid tool for investing, they also have their own strengths and weaknesses that should be considered. The following is a list of the advantages and disadvantages of a Certificate of Deposit to consider:
Advantages of a CD
- Flexible Terms: The terms and the amounts that can be deposited into a CD are flexible. If you are not willing to tie up your money for a long time, you can easily opt for a shorter term. At the end of a CD term, you can renew that CD or start a new one.
- Safety: CDs that are available from a federally insured institution are generally insured up to $250,000. This takes much of the risk out of the investment.
- Better Return Than Saving Accounts: Since the CD holder is not allowed to withdraw money freely like savings account holders, a CD is often more valuable to the financial institution. For this reason, the interest rate offered to a CD holder is higher than a traditional savings account.
- Wide Selection: You can get a CD at various maturities and terms from different financial institutions. Because of the diversity of CDs, investors can find a CD that meets their individual needs.
- Fixed, Predictable Return: The investor can be sure about getting a specific yield at a specific time. Even if the interest rates come down to a broader economy, the CD rate will remain constant. You will be able to easily determine the rate at which your balance will grow, thus making financial planning easy.
Disadvantages of a CD
- Limited Liquidity: The owner of a CD cannot access their money as easily as a traditional savings account. To withdrawal money from a CD before the end of the term requires that a penalty has to be paid. This penalty can be in the form of lost interest or a principal penalty. To increase flexibility, the investor can create a CD Ladder, which is composed of CDs with different maturity dates and terms. With a laddering strategy, you have more options to access your CD savings at different intervals of time.
- Inflation Risk: CD rates may be lower than the rate of inflation. This means that your money may lose its purchasing power over time if interest gains are outdone by inflation rates.
With these advantages and disadvantages in mind, it is wise to consider that CD advantages usually outweigh the disadvantages. CDs allow you to grow your savings without hassle. You can easily compare different types of CDs with the help of online resources, and you can find one that best suits your needs.
Summary of Certificates of Deposits
Certificates of Deposit (CD) are useful for people looking for a way to save money while earning a relatively high interest. This not only helps you save money, but also earns you interest without requiring any effort on your part. The disadvantages of CD’s are minor and typically outweighed by their advantages.