Making the right investment move to meet your financial goals and suit your budget can be tricky—and frustrating. Many people just dump any extra cash into a savings or money market account. That’s a safe strategy, but the interest rates are very low. There are smarter ways to put your savings aside and yield a better return without risk.
Certificates of deposit (CDs) or share certificates for credit unions are becoming a popular way to stash your cash in a safe place while earning higher interest. CDs differ from savings accounts in a number of ways:
- Savings accounts are liquid and allow you to withdraw cash when you need it, while CDs require you to keep your money on deposit for a specified period.
- The longer you keep your money in a CD, the higher the interest rate.
- Your CD is federally insured up to $250,000
If you are looking for a higher return on your deposit and are willing to commit your money for a while, CDs could be an ideal way for you to put money aside for retirement, college, a new car, a new home, or some other planned event. When shopping for CDs, it’s important to understand the advantages and disadvantages before making a decision.
The Pros of CD Savings
There are many reasons that savers are using CDs more and more. Here are a few of the advantages:
- Your money is insured up to $250,000, guaranteeing that you will never lose a penny of your principal. That makes them safer than other forms of investment, such as bonds or stocks.
- Certificates of deposit offer higher interest rates than savings or money market accounts. CDs can be a great way to diversify your savings strategy.
- CDs come in a variety of types and terms. Deposit periods can range from three months to 5 years, each at a different rate of return.
The Cons of CDs
Of course, CDs aren’t necessarily for everyone. There are some clear disadvantages that need to be considered before committing your money to a CD:
- Lack of liquidity. Once you put your money in a CD, it stays there, like a vault with a time lock. You are committing to the length of term until the CD matures. Of course, it is your money, and you can cash out early if you are willing to pay the penalty fees, which typically range from three to six months of interest, although some financial institutions have heftier penalties in exchange for higher interest rates. There are strategies such as CD laddering that let you withdraw money at intervals during the CD deposit period. Talk to your financial advisor to review your options.
- You could lose out on other investment opportunities. If your money is tied up in a CD, then you can’t transfer it to another financial product with a higher yield in the event interest rates change. You are locked in, so you won’t lose anything, but you can’t increase your interest margin either. There are variable-rate CDs with rates that fluctuate with the market, so your money earns more if interest rates improve and less if they drop.
- CDs don’t keep pace with inflation. If you keep your money tied up in a long-term CD—for example, for 10 years—the earnings may not keep up with the rising cost of living, so you could actually lose money. There are investment products that give you a hedge against inflation, but your best bet may be to choose shorter-term CDs.