A certificate of deposit, or CD, is an agreement between you and the bank of your choice to leave your money with the institution for a certain amount of time in exchange for a pre-set rate of return. People turn to CDs as a form of investment because they are safe and often give higher levels of return than a regular savings account.
Why do Banks issue CD’s?
Banks offer CDs so that they can gain access to capital used to make loans. The bank expects to make more in interest from the loan than they will pay you for your CD, so it is a profit venture for them. You take advantage of a guaranteed return and the bank uses your money to make more money.
What are the advantages of a CD?
There are several advantages to investing in a CD. The biggest advantage is that you can predict the rate of return on your investment as soon as you deposit your money. Your interest rate is set in advance and cannot go down, so you can easily determine how much money you will make through the period of your CD’s life. For example, if you invest $5,000 in a 12-month CD with a two percent rate of return, you would have $5,100.92 at the end of the year. It is easy to calculate the return on any CD if you know the time period and interest rate. Just do a Google search for CD Calculator and you can even find any online calculators to assist.
Another advantage to CDs is that they are very safe investments. Most bank deposits are guaranteed by the federal government so you know that your money will not simply “disappear” as it may do if you invest in other venues. You may not get as much in interest as you would with a higher-risk venture, but you will enjoy the security of knowing that you are making money on your investment without a risk.
What are the downfalls of investing in a CD?
One disadvantage of CDs is that they earn substantially less interest than almost any other form of investment. Due to the fact that you are taking almost no risk with your money, you cannot expect to earn a very high rate of interest. CD interest rates are tied to the prime rate and are usually relatively low; in recent years, some CDs have earned as little as one percent.
Another disadvantage of CDs is that you may lose some of your interest or principal if you need to access your money quickly. Cashing in a CD before the maturity date usually incurs a penalty; check with your banking institution to find the penalty rate. Because you have to pay money if you do not keep your CD active, it is a good idea to have, in addition to your CD investment, a savings account that charges no penalty for early withdrawal. Keep enough in your savings account to allow you to withdraw money quickly for emergencies so that you can leave your CD investment intact.
How do I buy a Certificate of Deposit (CD)?
CDs are also very easy to obtain. You simply visit a bank and ask for a CD; the bank will take your deposit and issue you a certificate with the maturity date printed on it. On that date, you can redeem your money along with interest if you choose, or you can choose to “roll over” your CD for another time period. If you choose to do this, the principal and the interest will all become principal, so you are earning even more interest with your investment. Some banks have automatic rollover if you do not cash your CD in by the maturity date, so be sure to ask about this at the bank where your CD is kept.
How do I find the Best CD Rates?
It is always wise to shop for CD interest rates just as you do for other items. There is a substantial difference between banks and investment companies in how much interest is given on a CD. One bank may be at one percent and another may offer three; this is a big difference over the life of your CD in the amount of interest you will earn. However, you must be cautious of firms offering exceptionally high rates of interest on CDs; in some cases, these investments are not guaranteed CDs at all. Instead, they are schemes to coax you into investing your money in a higher-risk venture. Always ask to see the documentation for the investment before you hand over your money.Only buy CD investments from reputable banks! These banks will usually be found right in your neighborhood, although there are several “internet banks” such as ING that also offer CDs.