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When you work hard to save money, you want to make sure your money is also working hard for you. One of the safest and stress-free ways to invest your money is a certificate of deposit (CD). These savings products are offered at most banks and credit unions with typically a higher annual percentage yield, or APY, than a regular savings or money market account. In exchange for the higher return on your investment, you agree to leave the money on deposit with the financial institution for a specified time period. Basically, set it and forget it.
Mature periods for a CD can range from three months to five years and everything in between. Generally speaking, you would expect to earn more the longer you agree to leave the money on deposit, but not always. Sometimes, a six-month CD can earn a higher rate than a longer-term product. Periodically, banks may also have special promotional CD’s for unique terms such as seven or thirteen months that earn a higher rate than other more standard terms. You will also find that CDs require a minimum dollar amount of purchase and even that there are different rates for a CD under $25,000 than over $25,000 for example.
CDs are considered low risk because you are guaranteed to receive a set amount stated at time of purchase once the CD term expires. However, if you withdraw the money before the end of the agreed upon time, you will typically be charged a penalty. While a CD offers low rates in comparison to most stocks, the funds are guaranteed through federal insurance from the FDIC at banks.
Another saving strategy includes a CD ladder, which is several individual CDs that mature on different dates. By investing a small amount at regular intervals, investors can jump in at any time and avoid trying to time the market on when rates may go up or down. Staying disciplined and reinvesting the proceeds from maturing CDs can help investors to ride out interest rate fluctuations and keep money earning interest.
A CD ladder is also one way to limit how much money you tie up at any given time. For example, suppose you have $20,000 to invest in a CD. If you put it all in one two-year certificate of deposit, you would lose the opportunity to withdraw any of it for that whole term. However, if you break it into four CDs of $5,000 each and stagger them so that they mature at six-month intervals, you will be able spend at least some that $20,000 should you need to unexpectedly.
A CD is also a great way to save for an expense that has a specific due date, such as a child's tuition or a down payment for a home. In such a case, you would set the CD term to coincide with the due date. This way you avoid the possibility that a dip in the stock market might lower the value of your funds when needed.
Components
A CD has several components including:
APY: the percentage rate the financial institution will pay you over and above the amount you invest when the term ends. APY on most CDs are fixed, meaning that regardless of what happens with the stock market, your APY will remain the same. For example, if your bank advertises a 4.5 percent APY for a one-year CD and you invest $5,000, you would receive $225 APY at the end of the year.
Term: the length of time you agree to leave your money invested.
Early withdrawal: this occurs if you take your money out before the end of the term. Financial institutions will likely charge you an early withdrawal penalty, usually forfeiture of interest, if this happens. The terms of the CD will be outlined when you open an account.
Principal: the amount of your original investment; for example, if you put $1,000 into the CD, then the $1,000 represents the principal.
Maturity date: the date at which your term ends.
To learn more about current CD rates, click here to visit our CD page.