Having a variety of places your money is invested in is a top sign of financial stability. In case of emergencies, there’s assurance that you have money readily available to you. There are a few ways to save an emergency fund utilizing bank/credit union services or making lifestyle changes. One method of saving money for a particular financial goal in setting funds aside is a certificate of deposit (CD). You might have heard of CDs before but not fully know if it’s the best way for your money to accrue interest compared to other savings accounts. By knowing the ins and outs of CDs, you’ll be able to determine if a certificate of deposit worth it for you:
- How CDs work
- Variations of CDs
- Pros of CDs
- Cons of CDs
- Qualities of Good CDs
- Alternative ways to invest money
How CDs Work
CDs are a specific type of savings account, but what makes them so different? When you deposit money into a CD, you are agreeing to keep the principal untouched for a set amount of time. A CD term can be anywhere from a few weeks to 10 years. Withdrawing funds before they mature could lead to paying an early withdrawal penalty (EWP) and having to close the account prematurely. Until the initial amount of money is able to be accessed at the end of the term, it will gain interest at a fixed rate.
These interest rates are much higher than savings accounts at major national banks which average around 0.04% APY. According to Bankrate.com, the average APY of a 1-year CD in June of 2021 is 0.17%. But the longer you agree to keep your money in a CD, usually the higher your interest rate will be. Some of the most highly-rated financial institutions have CDs with APYs over 0.70%. These higher rates may make a certificate deposit worth it to stow away money for an extended time.
Variations of CDs
For different types of financial goals and withdrawal needs, there are variations of a standard CD account. Here’s a quick summary of four other types of CD:
- Non-penalty CDs allow you to make withdrawals before a term end date if you need to liquidate funds on short notice. But these CDs have other restrictions. They may either have lower APY or require a higher minimum deposit than CDs already set.
- Step-up CDs have an interest rate that the institution raises automatically to match other market rates. This only benefits the user if rates are expected to increase and are on the bank’s schedule.
- Jumbo CDs are similar to standard CDs but are meant for deposits over $100,000. Because of the larger amount, you can expect higher interest rates in return.
- Add-on CDs allow you to contribute more to a starting principal which will increase its return on gained interest. This is great for those who aren’t able to make certain minimum deposits and want to make saving money a habit.
Pros of CDs
Because of their nature, there are a number of factors that make a certificate of deposit worth it. The most appealing factor is their higher interest rates which have more return than typical savings accounts. At any given institution there are plenty of term options for short-term and long-term needs. Some of the more common term lengths are six months, 12 months, and 18 months. CDs are more secure than other methods of investing that can be volatile due to drastic market changes. That’s because you cannot lose any of your initial principal and rates are fixed from the moment you open your account. FDIC member institutions insure deposits up to $250,000.00 making CDs very secure investments.
COVID-19 has made an impact on the risk and reward of opening a CD. There are some new disadvantages to consider from the pandemic that we’ll touch on eventually. But the best advantage of having a CD from COVID-19 is the prevalence of no-penalty CDs. No-penalty CDs usually have lower yields but will allow you to withdraw funds early in full with no EWP. This option is more liquid than the standard CD in case of financial difficulties due to COVID-19.
Cons of CDs
So the main pro of a CD is its security when it comes to having a guaranteed profit. What might turn someone away from opening a CD? CDs are less liquid than other types of investments. That means if your entire emergency fund is saved in a CD but cannot be opened for months you will suffer a penalty or wait out the rest of the term. Just like other deposit accounts, you will be paying yearly taxes on the earnings you make from interest. The last thing to consider is inflation and if your account will gain value in the time your term will mature.
A con of opening a CD after the COVID-19 pandemic is that rates have been steadily decreasing since March 2020. Rates are determined by each institution but follow trends set by the Federal Reserve. Interest rates were slashed at the pandemic to ease economic damage near zero percent. This trend will most likely last through 2022 as well, but at least you could not miss out on a higher APY soon.
Qualities of Good CDs
Since a lot of banks and credit unions offer CDs with different features it’s important to choose a CD that aligns with your financial goals. There are a few characteristics to compare between institutions to help make a decision of where to open a CD. First is looking for an FDIC member bank to insure government regulation of a principal up to $250,000.00. Next is a minimum deposit to be placed in the account all at once and any fees to maintain the account.
Then compare term lengths to when you would like to use to transfer the savings in the future. Are you wanting to buy a car or pay for college in six months, three years, or even further away? When considering interest rates you also have to look at the current state of the economy. If you believe rates will rise soon, choose to open a CD when rates are highest. Lastly, it’s key to confirm any penalties like EWPs and anything that would distinguish the account from a standard CD. Will interest rates rise when market rates rise? Are partial withdrawals allowed?
Alternative ways to invest money
So after considering the qualities of CDs you might be thinking is a certificate of deposit worth it and what are some alternatives? A CD isn’t the only way to set away money for short-term investments that will have guaranteed profit. What’s most often compared to CDs are high-yield savings accounts. High-yield savings accounts can have similar APY to mid-length CDs but can be contributed to over time. Despite the limited withdrawals and possible fees, they are still more liquid than a standard CD. CDs are also compared to buying stocks and bonds which have the possibility of higher profit. Both involve investing in corporations although bonds come in a variety of forms. The risk associated with stocks and bonds, unlike CDs, is that there is a chance of losing some of the original principal.
Like this content and want more? Read more law and finance here. Subscribe to Dock Line Magazine and receive free content like this in your email.