Music CDs may have fallen in popularity, but another type of CD is here to stay—certificates of deposit. These investments allow you to do something fun with your money: deposit it in a bank at a high interest rate, get their assurance that it will be paid back in full, and then simply collect the deposit amount (plus interest) at the end of your term.
However, a CD is a bit of a complex investment, as the fine print will vary from institution to institution. If you have some extra cash to invest, here’s what you need to know before you open a CD.
What exactly is a CD?
A certificate of deposit is an option to grow your savings in which “you choose the set period of time to earn a guaranteed fixed interest rate, regardless of market conditions.” In other words, you deposit a certain amount of funds in a bank, agree to a term length, and then accept a specific interest rate, which the institution will pay back on top of your initial investment at the maturity date (when the term ends). As you can see, it’s a very similar situation to taking out a loan from a borrower, except CDs position you as the lender.
What CDs do for you
The goal of investing money is to place funds somewhere they will grow passively, after which you amass financial gains. While this isn’t necessarily the result of all investments, and some can certainly depreciate in value, CDs offer an almost guaranteed return. This investment type is one of the most secure yet profitable—for an ideal balance of returns and peace of mind that every dip in the market isn’t going to hurt your bottom line.
This is due to a CD’s fixed interest rate agreement. Not only does it exceed the rates of other deposit products, such as savings accounts, but it also rate remains unchanged, even as market conditions like federal interest rates or stock market conditions waver. When investing in the stock market via an account like a mutual fund, your rate of return can be as fickle as the weather—which can impact stock prices and thereby your profit or loss from said investment. A CD, meanwhile, is significantly lower risk (though it may not result in dividends as lucrative as the stock market offers).
Of course, this doesn’t mean that CD rates never fluctuate; institutions change them all the time. However, this only affects the rates available to you when you open your CD. Once you hand over your funds and open your account, that interest rate becomes permanent—and you receive the bank’s written agreement to return your money with interest.
What to consider before you sign on
Like any investment, a CD isn’t for everyone. Take the following steps to determine whether this is the right investment for you.
Count your cash
Many institutions have a few guidelines that you must follow, the most immediate being a minimum investment. As of April 2023, Wells Fargo has an opening deposit minimum of $2,500, and some institutions demand an even larger sum. Their higher-yield products, meanwhile, require at least $5,000 up front. Many institutions, especially small ones like credit unions, have a lower investment minimum—PenFed’s is only $1,000. You must pay the minimum investment amount in full in order to open a CD at all, and you cannot make payments in installments. In most cases, you also cannot add funds to your account before the maturity date. So before you make any moves, first consider how much money you have freely available to invest, and select your amount carefully.
Watch the calendar
CDs are unique among investment types for their strict time guidelines. No matter the institution’s advertised interest rate, each one’s funds grow in direct proportion to the term length; this means that the longer you invest, the more money you can expect to make in interest.
However, be mindful that whatever maturity date you select is set in stone. As Sarah Hansen writes for Money, “If you need to withdraw your money earlier than your term allows . . . you should be prepared to pay a penalty. That penalty could be a portion of the interest you would have earned on your deposit, or it could be a flat fee.” Think hard about how much money you’re willing to hand over—and how long you can tolerate living without these funds.
Determine your financial goals
While most financial experts recommend paying down debt as the wisest use of extra cash, many people use them as a form of high-yield savings account to pay down larger expenses in the future. However, only you can decide if a CD is suitable for your current finances, risk tolerance, and future financial goals. It’s highly recommended that you discuss investment opportunities with a financial advisor before arriving at a decision. But even if you make the jump to open an account, it’s unlikely to fail you—such security is key to this investment type’s enduring popularity.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
CD’s are FDIC Insured and offer a fixed rate of return if held to maturity.
Within this communication, the term “financial advisor is used to refer to registered representatives and/or investment advisor representatives affiliated with LPL Financial LLC.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by ReminderMedia.
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