Many people look to build up some savings in case they need them in the future. Standard savings accounts may not give fantastic returns and many will invest their savings in one or more certificates of deposits (CDs) as an alternative. How do these products work and are they worth it?
What is a Certificate of Deposit?
This savings account, like any other traditional deposit account, is designed to give the individual a return on their investment by paying them interest. The difference between CDs and other savings alternatives is that the individual will commit to tying up their savings for a set period of time with the issuing bank or brokerage.
This gives the individual the potential to earn more interest. They may, for example, invest a fixed sum in a CD to get a specific rate of interest that is paid according to the CD’s schedule. Investment periods vary here but will typically last between 3 months to 5 years. Once the product has come to an end the individual can take their cash out or keep it in the account for another term.
The Advantages and Disadvantages of Investing in CDs
For many, certificates of deposit are the primary way to invest their spare savings. The advantages of using standard CDs for the individual include:
- Higher rates of interest compared to standard deposit accounts.
- Lower risk than many other investments as their principal investment is secure as long as they stick to the terms.
- Increased security as federal deposit insurance protects these investments to the tune of $250,000.
It is important to consider all relevant factors, however, before using this kind of investment. So, for example, the individual should be aware that:
- They may lose interest and perhaps some of their principal in penalty charges if they don’t stick with the term of the CD and want to take their money out early.
- They may not see the kind of high investment returns that may be found with other investment products.
- Some products may be available on a national basis but some may be reserved for local investors.
There are also various types of certificates of deposit to choose from within the financial sector so it is important to investigate the terms and conditions before investing. Whilst traditional products will give a fixed rate of return for their investment period others may offer variable rates and different terms that may make investment a little less secure.
Bear in mind as well that shopping around to find the best investment deals may be worth doing. Interest rates and deals may vary widely and using a CD yield rate comparison site or service online may give a quick snapshot of the best options in terms of returns. This may also be useful if the individual is looking to set up a CD laddering strategy.