Is a CD the Right Choice for You?
Certificates of deposit (CDs) are a worthwhile investment when market conditions are right. However, you must also be in a solid financial state if you're able to lock up your money for an extended period of time. CDs can be a safe way to grow money, but you must be comfortable not having access to the funds for the duration of the account's term. CDs are worth it when the following circumstances apply:
• Interests rates are high, and you don't expect them to rise significantly over the course of the CD's term.
• You have extra money sitting in a bank account.
• You already have a separate emergency fund in place.
• You are trying to save up for something big, like a home or car, and want to earn a good return without market risk.
• You are looking for ways to grow money without the temptation of spending it.
In low interest rate markets, CDs are less enticing because returns are often fairly miniscule. As interest rates rise however, CDs become a much more attractive method of investing money.
Another advantage of a CD is that your starting rate is guaranteed. Therefore, you cannot lose money with a CD (though you could lose accrued interest if you withdraw money early). This is as opposed to investing in equities and other securities, where you can end up losing your investment if things go poorly. CD deposits also have the backing of FDIC insurance, up to $250,000. So if your banking institution were to fail, you would still be covered.
CDs are a solid option if you have extra money sitting in your accounts, as long as said account is not your emergency fund. Excess cash that is either not accruing interest or accruing low interest could likely be better served in a CD. The fee associated with withdrawing from a CD before the maturity date also acts as a strong deterrent from spending the money you're saving. It makes CDs ideal for anyone trying to save up for something in the long-term.
What CD Term Should You Go With?
It’s important to create a clear set of savings goals when determining the correct CD term for your needs. Opening up a CD and having to withdraw from it early can mean you lose money, so don't open one unless you're sure you won't need the money until the term is up. The penalty can also be great enough where you could have ended up earning more in a liquid savings account, so don't discount the fact that maybe a CD is not the right option at all. You need to be honest about your finances and what your short- and long-term objectives are before committing to a term.
If your goal with a CD is just to grow money in a safe environment, then building a CD ladder with multiple accounts of varying lengths may be the optimal way to go. Laddering $10,000 across five accounts spanning one- to five-year terms can yield you about $1,200 after five years. In comparison, reinvesting $10,000 in a 1-year account for five years (which gives you the same liquidity as the ladder) would yield you about $300 less over the same time frame.
If you have a more focused goal in mind, like saving up for a car or home, you need to determine when you would like to make those purchases and pick the appropriate term. It’s a good idea to consider your job stability in your decision as well. Investing a significant amount of money in a 5-year CD could put you in a bind if you end up needing liquidity before the account matures.
