A certificate of deposit (CD) is a popular savings and investment option because it typically offers a safe and predictable return. When you put money into a certificate of deposit, you agree to keep it there for a specified period of time, and in exchange, you receive a fixed return on your investment.
How Does a Certificate of Deposit Work?
A certificate of deposit (CD) is also known as a time deposit. The way a certificate of deposit works is that you agree to deposit a specific amount of money into the certificate for a designated time period. Generally, you cannot withdraw the funds before the time period ends without incurring a penalty.
Once the time period is over, you can withdraw your money from the certificate of deposit, or you may choose to roll that money into a new certificate of deposit. At the maturity date, you will receive a fixed amount of interest.
Certificates of deposit have some unique advantages and disadvantages worth considering. To start, they tend to offer higher interest rates than regular savings accounts. Their guaranteed return also makes it easier to plan the growth of your investment. Most CDs are insured by the FDIC or NCUA (if you get your CD from a credit union), so they are considered safe investments.
On the other hand, certificates of deposit aren’t very flexible. Typically, you cannot withdraw your money from the CD before the maturity date without incurring a penalty. This can tie up your money for months or even years at a time. If market conditions improve and interest rates rise for savings accounts and certificates of deposit, your money may be locked into a CD with a lower interest rate.
4 Reasons to Open a Certificate of Deposit
Whether a certificate of deposit is a good investment option for you depends on your unique financial situation and market conditions. Let’s take a look at some scenarios when opening a CD might be appropriate.
You’re Working Toward a Long-Term Savings Goal
Certificates of deposit can be great ways to earn interest on short-term savings goals like a down payment on a home or saving money for a larger investment in the near future. This investment option often makes more sense when you’re younger and working toward major financial goals. For example, if you know you still have a few years before buying a home, putting your down payment money into a certificate of deposit can help you earn interest on your savings and increase the amount you’ll have when you’re ready to take the next step.
Note: You can choose the term of your certificate of deposit, which can be as short as a few months or as long as five years. Those options allow you to align your investment with your current savings timeline.
You Want a Low-Risk Investment
One reason certificates of deposit are so popular is that they are known to be low-risk and provide a guaranteed rate. If you purchase them through a government-insured bank, they are insured up to $250,000.
Because of this security and guaranteed return, CDs are low-risk investment options, making them suitable for growing money associated with higher risks (like a college fund). Investing money in a brokerage account, for example, can be significantly riskier. Although CDs may not offer a strong return like other investments, they are considered a conservative investment, which may be a trade-off worth making.
You Don’t Need Immediate Access to Your Money
Certificates of deposit tie up your money for a specified period, and there are penalties for early withdrawals that will affect your returns. As such, this investment may only be suitable if you don’t think you’ll need access to your money during the designated time frame. Make sure you have cash available for your needs before putting money into a certificate of deposit.
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The risk with certificates of deposit is that inflation will grow faster than the money held in the certificate, which is another reason that tying up funds in a certificate of deposit can be annoying.
Current Certificate of Deposit Rates
There are times when certificate of deposit rates can be very low to be a worthwhile investment, so it’s a good idea to evaluate the situation based on market conditions. For example, if certificate of deposit rates are at 0.1% when you open one, it wouldn’t make sense to lock in those rates for five years when market conditions are likely to improve during that time. If certificate of deposit rates are very high at 10%, you might want to secure an investment at that rate.
Note: It’s always a good idea to shop around for certificates of deposit at different banks and credit unions to see which institution will offer you the best interest rate.
Alternatives to Certificates of Deposit
A certificate of deposit is just one option available to you when it comes to saving and investing. Here are some other options you may want to consider:
Money Market Account
A money market account is more flexible than a certificate of deposit since you can withdraw money from it up to six times a month.
High-Yield Savings Account
A high-yield savings account works like a regular savings account but offers a higher interest rate and may come with other benefits such as no fees or a low account balance.
Are Certificates of Deposit Worth It?
Whether a certificate of deposit is worth it depends on your financial situation and current market conditions. If a certificate of deposit comes with a high interest rate and you don’t need access to your funds for a set period, it can be a safe and effective way to grow your money. If current certificate of deposit rates are low or if you need more liquidity, you may want to opt for a more flexible investment option instead.
Frequently Asked Questions (FAQs)
How do I open a certificate of deposit account?
You can open a certificate of deposit account through a bank or credit union. Once you choose the term and amount to be deposited, you can fund the certificate and specify how you want to receive interest payments (usually they can be monthly or annually).
How much money do I need to open a certificate of deposit account?
A certificate of deposit may have minimum funding requirements. Each bank and credit union offering a certificate of deposit will inform you of the amount you need to deposit to qualify. They often offer different interest rates for different deposit amounts.
Where can I get the best certificate of deposit rates?
It’s always a good idea to shop around for certificate of deposit rates at different banks and credit unions to see which institution will offer you the highest interest rate so that you can earn the most from your investment.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
FINRA. “Certificates of Deposit (CDs).”
Investor.gov. “Certificates of Deposit (CDs).”
Source: https://www.thebalancemoney.com/why-open-a-cd-5524663
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