Investing in a certificate of deposit (CDs) is an excellent way to diversify your investments. However, the first step starts with learning what a CD is and how it works. A CD is a federally insured savings account, but unlike a regular savings account, you must keep your money in the account for a certain length of time. In addition, there will be monthly interest payments are made on the money in the account.
All CDs come with a maturity date. So, the initial amount of money you put into the account is made available to you as a total with the interest payments that have been made on the amount of money originally invested. It is important to note that withdrawing the funds in your CD before the maturity date comes with a penalty. That’s why many choose to invest in multiple different CDs with varying maturity dates. You can also buy different types of CDs such as variable-rate, bull, or bear. You can also purchase CDs through financial institutions like banks, credit unions, and brokerage services. Many CDs do not have a minimum investment, but some require you to put down a minimum of $500, $1000, or even more.
Many choose to invest in CDs because they are generally predictable as the FDIC protects against bank failure while the NCUA insures CDs bought through a credit union. CDs also usually have higher interest rates than other accounts because of the lack of withdrawal options.
While there are multiple benefits to investing in CDs, there are some risks associated with it. For instance, interest rates might fall as money sits in the account. So when CD reaches its maturity date, you can invest the money into another CD. You will then be offered a lower interest rate. On the other hand, interest rates could rise. So if your CD is not yet at maturity, you could miss a higher rate.
Another risk is that CDs come with withdrawal penalties if you take their money out before the maturity date. Different CDs have different penalties ranging from a loss of 30 days of interest to a whole year’s worth of interest. This might be a concern as people go through periods of time where they are more financially stable than other times. For this reason, there are multiple strategies people use in order to compensate for these risks.
One strategy is a CD ladder in which the same amount of money is put into various CDs that have different maturity dates. It is called a “CD ladder” because the different maturity dates act as different rungs in the ladder. As a result, this money can be used for personal needs or be reinvested. A CD ladder also helps people adjust to changing interest rates. If interest rates rise, you can be extended their ladder which gives them access to these higher rates and vice versa.
Another strategy related to the ladder strategy is the barbell strategy. If you need money in a shorter time, you can put a certain amount of money into a short-term CD and another amount into a CD with a longer maturity date.
If you have more of a long-term goal, the bullet strategy might be a wise option to employ. You buy a new CD every year and all of them will mature at the same time.
Along with different investment strategies, there are also different types of CDs that can help you reach your investing goals. One of these variations is called a Bear CD in which the rate of interest increases when the value of a benchmark index decreases. People who want to hedge against potential losses in other fields buy these CDs. There are also Bull CDs that increase the rate of interest when the value of a stated benchmark index increases.
Some other variations include a Bump-up CD that allows investors to increase the rate of interest paid on the CD. Another is a Callable CD that can be redeemed before the maturity date. A Jumbo CD requires a minimum investment, higher interest rate, and can be sold to other investors before the maturity date. There are also Uninsured CDs that don’t have insurance but higher interest rates. Variable-rate CDs pay interest depending on the rate of a benchmark index. Yankee CDs are issued by foreign banks. Lastly, a Zero-coupon CD that can be bought at a discount and return with one interest payment.
Bottom line, even though CDs are generally safe to invest in. You should do your research on the CD and how it suits your investment strategies and your financial standing.