Imagine if we could put money into an account and watch it accumulate heavily, but only if we don't touch it for a while. In a world like this, we could secure our funds with minimal risk while benefiting from higher interest rates than a regular savings account. This is essentially how your certificate of deposit can work if used correctly.
The definition of a Certificate of Deposit (CD) is a financial product that allows you to lend money to a bank or credit union for a set period of time, called the term. In exchange, you'll receive a fixed interest rate and guaranteed return of your initial deposit if you keep the money in the account for the entire term. If you withdraw funds before the term ends, you may be charged a penalty fee that could be deducted from any interest earned or even your principal.
How a Certificate of Deposit works
1.) Initial Deposit - You deposit a fixed amount of money into the CD.
2.) Term Length Established - You agree to leave the money in the CD for a specified term, which can range from a few months to several years.
3.) Interest Rate Established - The bank offers a fixed interest rate for the duration of the term. This rate is typically higher than what you'd find with a regular savings account.
4.) Maturity - At the end of the term, the CD matures, and you can withdraw your initial deposit along with the accrued interest.
Types of CD's
1.) Traditional CD - The most common type, with a fixed interest rate and term.
2.) Bump-Up CD - Allows you to "bump up" to a higher interest rate if rates rise during your CD's term. You can establish the higher rate.
3.) Liquid CD - Offers the flexibility to withdraw funds without penalty, though typically at a lower interest rate. More safe but less money long-term.
4.) Jumbo CD - Requires a larger minimum deposit, usually $100,000 or more, and offers higher interest rates. Riskier option but its the best if you have the funds and the time!
5.) IRA CD - Held within an Individual Retirement Account (IRA), combining the benefits of a CD with the tax advantages of an IRA. We will talk more about IRA's in an upcoming article on FinanceIntact.
Benefits of a CD
CDs usually offer higher interest rates compared to traditional savings accounts, making them an attractive option for those looking to earn more on their savings. Additionally, CDs are considered low-risk investments. They are typically insured by the FDIC (Federal Deposit Insurance Corporation) up to $250,000 per depositor, per insured bank. Going hand-in-hand, with a fixed interest rate, you know exactly how much you will earn by the end of the term. Further, CDs can be a good addition to a diversified investment portfolio, giving you more stability in your financial gains and more flexibility, too.
The cons of having a CD
Early Withdrawal Penalties: Withdrawing money before the CD matures usually results in penalties, which can take from your interest earnings.
Inflation Risk: If inflation rates rise significantly, the fixed interest rate on your CD might not keep up, reducing your real return.
Limited Liquidity: Your money is tied up for the term of the CD, making it less accessible in case of emergencies. Even if you break the term and reach in for your money, you will then be penalized for it. Thus, in the case of emergencies, you will just lose more money.
Certificates of Deposit are a reliable, low-risk investment option that can help grow your savings over time. Understanding the basics of this safe investment option can help one to diversify their investment portfolio, make long-term gains, and gain high interest on their money. Thus, if you're looking for a safe place to keep your money and earn a bit more interest, a CD might be right for you and your investments.
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