Published in: Banks | Oct. 2, 2019
By: Maurie Backman
Here's why a certificate of deposit may be a great choice for you.
Many people live paycheck to paycheck and struggle to save money. But what if you're in the opposite position -- what if you have extra money on hand, and you want to put it to work? You could stash it in a regular savings account and earn a modest amount of interest, or you could invest it in stocks, bonds, or even real estate for added growth. All of these are viable options, but here's why you may want to choose a certificate of deposit, or CD, instead.
When you invest in stocks, bonds, or real estate, there's always a chance that their value will go down rather than up, especially in the short term. The stock market could have a bad year; bonds might drop in value; and real estate ventures could fizzle. But when you put money in the bank, whether in a traditional savings account or a CD, your principal is protected provided it doesn't exceed $250,000 per depositor. This means that if you have a joint CD with a spouse, your first $500,000 is guaranteed.
Now, for the record, it's really not a good idea to invest that large a sum in a CD. But if you're sitting on a few thousand dollars and want to earn some interest on it without putting your principal at risk, a CD is a good bet.
When you put money into a CD, you're required to lock it away for a preset period of time or otherwise risk a penalty for withdrawing your cash early. Savings accounts don't have this requirement; you can take out your money as you please. But in exchange for committing to leaving your money alone, CDs pay higher interest. In fact, the longer-term your CD, the higher the interest rate you're likely to snag -- meaning a five-year CD will typically pay more than a one- or two-year CD.
As the time of writing, for example, some of the top one-year CD rates are hovering between 2.4% and 2.8%, whereas you can get up to 3.10% on a five-year CD. But often, you'll see an even wider gap than that.
As mentioned earlier, the downside of putting money into a CD is that you'll risk a penalty if you withdraw against it before its term is over. That penalty is typically the equivalent of a few months' worth of interest (there's no preset penalty, as it varies from institution to institution). That said, you can avoid early withdrawal penalties by laddering your CDs so that you're not tying up too much money at once.
Laddering is a strategy used often with bonds, but it works well with CDs, too. The process involves spreading your money out over a series of CDs that come due at different times, rather than sinking all of your cash into a single CD with the same term. For example, if you have $4,000 to work with, you could stick all of it into a five-year CD and call it a day. Or, you could put $1,000 into a one-year CD, another $1,000 into a two-year CD, an additional $1,000 into a three-year CD, and your final $1,000 into a five-year CD. That way, you're freeing up money at various intervals, thereby minimizing the risk of needing to make a premature withdrawal.
Certificates of deposit offer a great opportunity to earn interest on your money without the risks associated with other types of investments. Just be aware that some CDs require a minimum investment, which can be as little as $500 or as much as $5,000. If you don't have enough money you want to save, you may not manage to get the best rates out there, but if you can make those minimums, a CD could be your ticket to easy growth on your cash.
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