Those looking to invest their money wisely and come away with more money naturally tend to look for something safe. Risky investments have their benefits, but sometimes you want to know that you'll almost certainly get your money back with a decent return.
For this reason, some people choose to invest some of their money into a CD, or a certificate of deposit. Often, a CD account is used in lieu of a savings account. But what's the difference between the two? What types of CDs are there, and what are the risks?
There's a lot to understand about certificates of deposit before deciding whether you want to put some of your money into one for several years. But if you decide it's the right call for your money, a CD can prove to be a safer option that lets you gain solid interest. Here's what you need to know about CDs.
Certificate of Deposit Definition
A CD is an example of a time deposit, and has a fixed maturity date and interest rate. The term length between when you open a CD and when you reach that maturity date can vary; while allowed, they rarely end up being too short or long. Common term lengths for certificates of deposit can range anywhere from 6 months to 5 years.
What separates a CD from a savings account is your ability to access the funds. You're allowed to withdraw money from a savings account at your leisure, but when you put money into a CD, it is to be stored away until the maturity date, untouched and gaining interest. These accounts are insured by the Federal Deposit Insurance Corporation (FDIC) and/or the National Credit Union Administration (NCUA) up to $250,000.
CDs also provide more interest on your investment than a savings account, adding up exponentially more. This makes a CD a sound plan if someone is looking to keep money saved away for a few years prior to a large purchase to ensure they still have the funds for it. Banks and credit unions will offer you various rate options depending on the maturity date, and often there is a minimum amount you have to put into your CD.
Let's say you open a CD account with a maturity date of 24 months and an interest rate of 2%, and you put $8,000 in. In two years, the maturity date expires. Thanks to the interest/annual percentage yield, or APY, you not only have your original $8,000 but the accrued interest as well, coming to a total of $8,323.20.
The interest rate for your CD goes a long way toward determining whether it's a worthy investment choice. After all, if you're putting the same amount of money in regardless of where you put it, and if you know you're getting that money back (even if a bank goes under, the government reimburses you for an FDIC or NCUA-insured CD), so many people look for one where they'll get the best return.
Bank CD Rates
Different banks offer different interest rates for your CD. What's the right one for you and where can you find the larger ones? Online banks generally tend to offer higher interest rates than other banks, due to not having to deal with overhead costs of having actual branches and maintaining the buildings. On particularly high rates, there could potentially be APYs of 3% or more if you look in the right places.
If you're not satisfied with the rates you're finding at banks and credit unions, you're welcome to ask them to try and raise it. Opening a CD account in a bank means you're letting that bank have your money for extended periods of time; there's incentive for them to offer good interest rates in exchange for storing your money with them for 5 years (or whatever amount of time you choose). You're free to talk to a number of banks and see if they can raise their offer.
Sometimes it can be helpful to know the interest rate you want for your CD before you even talk to a bank. There are calculators to determine what your return on a certificate of deposit will be. Some banks even have CD calculators on their own website, like Nationwide. Input what your initial deposit will be, how long you intend on keeping your deposit in, your desired interest rate, and when you want the interest to compound (often annually). Knowing what you may be able to get in advance can be a big help before actually opening your account.
True to the title, a jumbo certificate of deposit is one where exceptionally large amounts of money are kept - generally a minimum investment of $100,000. Jumbo CDs are seen as a low-risk investment for those seeking to invest such enormous amounts of money - as long as you keep your money in for the entire time, you'll see a return on it.
There are several reasons someone may choose to put all this money into a jumbo CD. Some establishments allow for particularly short maturity dates for jumbo CDs - as little as 7 days. You can keep your money safely stored there for a limited amount of time and quickly make some additional money off it. In some cases, a jumbo CD can be used as collateral when taking out a loan with a bank.
But there are drawbacks. Interest on CDs are fully taxable, and dealing with larger sums in jumbo CDs means paying more in taxes. In addition, the way to get the best return on a jumbo CD is to have it stored away for a considerable amount of time. But $100,000 or more is a lot of money to just keep away for 5 whole years.
Jumbo CD Rates
If banks want the money from your standard certificate of deposit, they're definitely going to want the exponentially larger sum contained within your jumbo CD. So interest rates for jumbo CDs tend to be higher, and you may have less trouble finding rates near 3% for them than other certificates of deposit.
Early Withdrawal Penalty
CDs can be safe and more risk-averse than other options, but they can have their drawbacks. For one, that deposit cannot be accessed until the maturity date. It's something you should only do if you are absolutely certain that you will have the necessary funds accessible otherwise, and can afford to put some additional money away into a CD.
Let's say that in an emergency, you do need to get your money out of the CD account. You're technically allowed to take your money out early, but you'll encounter an early withdrawal penalty that will vary depending on what bank or credit union you are using and how early you withdraw. Different establishments have their own specific penalties that you should find when comparing places to open your account, but as a general rule of thumb, the more time that's left on your account, the harsher the penalty. Withdrawing your 5-year CD account long before those 5 years are up could see a penalty of 12 months' interest.
You know the types of CDs you can deposit money into, how much you can put in, and what might happen should you need to withdraw early. Certificates of deposit aren't for everyone, but if you've made it this far and decided it's still the way you want to go, you'll also want to look into some of the different CD accounts that are at your disposal.
There are several different options that could be worth your time. Some establishments offer bump-ups, where during the duration of the CD you can at some point request a higher interest rate. Individual retirement accounts can hold CDs, an investment within your IRA. Here are a few other notable types of CDs you may consider.
High-yield CDs were mentioned earlier - they're the ones with the highest, most competitive rates, allowing the investor to receive a much higher yield once the fixed maturity date expires. It's how banks and credit unions make their case that they should be the place where you open your account.
A high-yield certificate of deposit certainly sounds like the most tantalizing type, but don't be surprised if that high interest rate means a higher minimum deposit, too. You may find a reasonable minimum, but some places near you could require thousands of dollars in your deposit.
A brokered certificate of deposit, as opposed to ones opened directly with a bank or credit union, use a brokerage as a middleman. You'll need a brokerage account for this.
Brokered CDs have pros and cons. Through a brokerage, you're offered the options of banks without having to go from one to the next to pick one. However, there is still homework you'll need to do. An unsafe bank in the mix may offer a high yield but not be insured by the FDIC. Brokered CDs can also be bought and sold - but that opens up a generally safe option to the risk of the open market.
No Penalty CD
Also known as a "liquid CD." The fact that you can't take your money out of a CD until the maturity date is necessary in order to get the best return on it, but it can feel like a nuisance at times. No-penalty/liquid CDs offer you the option of withdrawing money prior to the maturity date, without incurring a penalty.
This can be extremely helpful if you need the money for an emergency. But there are some negatives to it also, mainly that the interest rates offered for liquid CDs tend to be lower. Essentially, a no penalty certificate of deposit is the opposite of high risk, high reward - it's lower risk, but less of a reward.
Though a liquid CD can be less of a reward, the reason some find it worth it is that they want to make sure they have access to that money. It's a legitimate concern, and it's not the only one people have with CDs. Putting a lot of money away for a year is a long time, no less 5-10 years.
One strategy some CD investors will use when concerned with this is called a "CD ladder." With a CD ladder, you take the money you want to deposit and divide it into multiple CDs with different maturity rates in lieu of one CD. For example, if you're looking to deposit $10,000 into one CD, you could instead divide it equally into five different $2,000 CDs with maturity dates of six months, one year, two years, three years and five years. In doing this, an investor can get the high yield of a long-term CD without having to worry about not having money available.
It's difficult to predict with pinpoint accuracy when interest rates will rise, so it's wise to not use that as a reason to ladder your CDs. However, in the event that interest rates do rise, you can take the money received from shorter CDs and reinvest them with the new interest rates - all while still having the more long-term CDs maturing.