Certificates of Deposit (CD’s) are one of the safest investment vehicles out there. If you want to be at the low end of the risk/reward spectrum, CD’s might be the right choice.
CD Basics
CD’s pay you interest on your money very much like a savings account, but your earnings are typically higher with a CD. Go ahead and compare for yourself: you should find that CD’s pay a higher APY than a savings account.
Why Do CD’s Pay More Than Savings?
When you buy a CD, your bank is doing you a favor by paying you higher interest. Why would they do you any favors? They expect that you will return the favor by keeping your money in the CD for a specified period of time. This gives them some certainty and ability to use your money for other purposes (such as lending it to other customers or investing it).
How do CD’s Work?
Getting a CD is easy. Simply tell your bank or credit union that you’d like to buy a CD. They’ll most likely have a simple form with some disclosures. Then, they move the money into the CD for you. You don’t need an actual certificate – usually you’ll just see a distinct category for the deposit on your statements.
CD’s pay interest at some point. You can choose to reinvest that interest, or spend it. I suggest reinvesting if you’re really trying to make the money grow. Once you start earning interest on your interest (compounding) your account grows faster.
When your CD matures you usually have a window (10-15 days in many cases) of time to decide what to do next. Usually, your bank will automatically reinvest into a new CD if you don’t give them alternate instructions. Make sure you know the policy, and that you give proper instructions if you don’t want the money rolled into a new CD.
If you want the best CD rates, set yourself up for success. First, check our CD Rate Scorecard to see what the most competitive institutions are doing. Now, pick your product.
Time and the Best CD Rates
CD’s with longer maturities (time periods) pay higher rates than those with shorter maturities. This is because you’re promising to leave the money with the bank for more time, and they reward you for this. Try comparing for yourself. You’ll see that the best CD rates have the longest maturities, although there are always some surprising exceptions.
Keep in mind that the economy in general dictates what “competitive” interest rates are, and that influences what the best CD rates are. Rates could rise or fall (see Bank CD Rates for more details). You need to decide whether or not you should lock your money up long-term for a higher rate, or whether you should wait and see if rates will be more favorable in the near future.
Shop for the Best CD Rates
Next, you need to shop around. Try checking your local banks and credit unions to see if anybody is “having a sale”. You’ll often find that an institution needs to get deposits on the books quickly, and they know that one of the best ways to do this is to offer the best CD rate available locally. You’ll see these advertised on banners and in the newspaper.
Another great place to shop is online. Online-only banks offer some of the best CD rates all the time. They have lower overhead than the brick-and-mortar banks so they can pass the savings on to you.
A third place to shop is with a brokerage firm. Although you may not know it, your financial advisor may have some of the best CD rates available. Advisors have access to brokered CDs, which are typically sold in larger blocks. Make sure you work with somebody you trust and that you know the risks – getting out of a brokered CD before maturity can be expensive.
Finally, check some of the personal finance blogs on the Web. These people do a great job of searching out the best CD rates and spreading the word.
Valued Customers Get the Best CD Rates
Finally, financial institutions offer the best CD rates to their best customers. To qualify for their best CD rates, you may need to meet a minimum investment requirement. Find out how much it would take to secure a higher rate. If you can afford it, take advantage. Sometimes it helps to consolidate your business with fewer providers – just remember to keep your accounts within FDIC insurance limits.
If CD’s are sounding good to you, let’s take a step back and look at some pitfalls.
First, you need to lock your money up. If you want to get it back before the CD matures, you should know that you may have to pay a penalty. Ask your bank exactly what the penalty will be.
Next, if safety is important to you, make sure that your bank is FDIC insured. Look for the phrase “Member FDIC” or the FDIC logo.
Remember that credit unions are not FDIC insured, rather they are insured by the National Credit Union Administration (NCUA)– so they won’t be in the FDIC’s database. NCUA insurance is just as strong as FDIC insurance in my opinion.
Finally, remember that because the risk level is relatively low, your reward might also be relatively low. There are various types of risk, including the risk of losing your money and the risk of losing purchasing power. CD investors have a relatively low risk of losing their money (due to a banking system failure).
However, CD investors have a relatively higher risk of losing purchasing power over the long-term. Long-term investors should at least familiarize themselves with the alternatives and risks associated with other investments.
Article Source : Justin Pritchard (http://banking.about.com/od/cds/a/cdbasics.htm)
