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December 10, 2020
Financial Freedom

CDs Never Went Out of Style - What is a Certificate of Deposit?

 

CDs can provide higher returns than other conventional savings options while still being just as secure as your checking account. Read on to learn how they work and to find out if they could be part of your overall financial strategy.

 


 

CDs are available from many financial institutions, and they work similarly to savings accounts, though they may require a minimum deposit. At Trustmark, for instance, the minimum investment is $1,000.

 

From a consumer perspective, the crucial difference between CDs and savings accounts, or higher-yield options like money market deposit accounts, is that the deposit is not liquid. That means you can’t access your funds without a penalty before a set amount of time has passed.

 

You decide on the maturity date of your CD when you purchase it, and this time frame can range from six months to five years.

 

While CDs may not carry the same potentially high rate of return as more aggressive long-term investments like retirement plans, stock accounts and mutual funds, certificates of deposit still have numerous advantages.

 

Benefits of CDs

 

Here are some of the main reasons that CDs are interesting for savvy savers and investors:

 

  • Qualifying CDs are insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Share Insurance Fund (NCUSIF), guaranteeing your investment.
  • While inflation rates and stock values can fall, CDs are a secure investment that guarantees growth, even in uncertain times.
  • CDs are often available at annual percentage yields (APYs) comparable to - and even surpassing - those for high-yield money market and savings accounts.

 

Let’s explore that last point a little bit further. According to the FDIC, as of June 2020, the average national rate for money market accounts was 0.09% APY for deposits less than $100,000. At the same time, the average national rate of three-month CDs in the same deposit bracket was 0.11% APY. The APY continues to climb for later maturity dates. Money market accounts may also carry higher minimum deposit requirements than CDs, providing a larger barrier to entry.

 

If you already have your emergency fund set up in a normal savings account or a high-yield money market account, but you still have additional savings goals, a CD may be the best way to go. This is especially true if you know you can’t afford to lose money, and you won’t need access to it for a certain amount of time.

 

What role do CDs play in my financial life?

 

There are several reasons that you might benefit from CDs, considering that they provide a comparatively high rate of return for such a secure investment. Even though they aren’t liquid, CDs can still prove to be a valuable tool for your financial future. Here are some of their specific uses.

 

Part of your retirement planning strategy

More risk-averse retirement savers may benefit from the security provided by CDs. Some individual retirement accounts (IRA) will allow the saver to invest in CDs.

 

It’s generally advisable to start saving early. Compounding returns and greater resilience from risk are two of the main reasons that it can be beneficial to save substantial sums for retirement during your early years. Still, if you find yourself making catch-up payments a few years before retirement, IRA CDs can be a more secure way to save.

 

You may be able to use CDs as collateral for a personal loan

On its own, the ability to take out CD-backed personal loans isn’t a reason to invest in CDs when you wouldn’t otherwise do so. However, this does limit some of the risks entailed in having your funds tied up in a CD.

If something unexpected happens, and you find yourself strapped for financial resources, you can allow your CD to continue to mature instead of cashing it out and taking the hit for early withdrawal. As long as you can pay those loans back with limited interest, you’ll still come out ahead.

 

Help with saving for a specific big-ticket, long-term expenses

Think of the big milestones in your life. Are you saving for anything that’s on the distant horizon? Let’s say you’re building up your funds for a hefty down payment on a new house, or maybe you want to be able to help pay for your child’s wedding. These events may be a few years in the future, and maybe you’re not done saving for them yet. They’re close enough in time that you definitely don’t want to risk losing what you’ve already saved.

 

If you have savings earmarked for these expenses already, consider parking that money in a CD. You can continue to accumulate further funds in a savings account alongside your emergency fund, periodically purchasing new, shorter-term CDs.

 

A stable cornerstone for your larger wealth management strategy

If you have a large portfolio of financial assets, saving some of your money in a CD can provide you with a secure financial backstop in case other assets of yours decline in value. Jumbo CDs, which are available for $100,000 or more, provide somewhat higher returns than standard CDs, and they can help you balance out higher-risk investments elsewhere in your portfolio.

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