CDs: The Most Misunderstood Investment Tool for Young Investors

Investing can seem intimidating, but it doesn't have to be. For those who are just getting started, there is one simple, but effective, way to grow your money: certificates of deposit (CDs). Unfortunately, there are some misconceptions about these tools, including the idea that they aren't useful for younger folks. This article is here to set the record straight and show how you can best take advantage of them as a young investor.

Here's what you need to know.

How CDs actually work

When you open a CD, you're agreeing to keep a certain amount of money stashed away in that account for a specific time period. In exchange, the bank will provide interest on that cash, which is significantly higher than you'd find with something like a traditional savings account. And, unlike many other account types, the interest rate is fixed, so you know exactly how much you're earning over that time period.

CDs have some drawbacks, such as the time requirement. For example, if you end up needing to dip into that cash during the term, you'll have to pay an early withdrawal fee, depending on how long the cash has been in there. So it's vital to make sure you can afford that risk by having some sort of savings available for unplanned bills. Banks may have minimum deposit requirements, too, which can also vary based on the CD's term.

An example of CDs in action

Let's say you have $1,000 that you want to invest in a CD, and you choose a 6-month CD with a 5% APY. By the end of the term, you'd get $25 in interest on your original investment. That's not a huge return, but it's certainly better than putting that cash into a low-rate savings account.

Why CDs are great tools for young investors

Obviously, the more you have to invest, the better. That's true for CDs, too. But as a young investor with, presumably, less money to put into various investing tools, a CD can be an excellent way to help protect your investments against market fluctuations. Even if you were to compare CD performance against something like a high yield savings or checking account -- which may have rates that match or even exceed some CDs right now -- there is one factor that you have to consider: the nature of the APY (annual percentage yield).

With CDs, the APY is fixed, so you know what you're getting back from the jump. But with a high-yield savings account, which can come with other requirements to access, you may see that rate decrease as banks adjust their offerings.

There are other methods you can use to grow your CD balances even more, too. For example, you could choose to split up your invested cash into several CDs that mature at different times, giving you access to some of that money faster, in case you need it. (This is called CD laddering.) Each time a CD matures, you could either cash it out or reinvest it in another CD.

Over time, a CD ladder can net you quite the financial cushion, especially compared to how much your money might grow (or shrink) if invested in the market, which typically is best for long-term investing. Plus, the longer you have to invest, the more you stand to gain. So while some may see CDs as an older investor's tool, they can be useful for anyone.

CDs aren't the most attractive investment vehicles, but they are safe (thanks to FDIC insurance) and can be great options for new investors who are looking to diversify their portfolios. Just make sure you're getting one that matches your circumstances and needs.