Updated: Mar 27
Everything you need to know to start investing in certificate of deposits (CDs) - learn what a CD is, the types of CDs offered and how to invest in a CD.
TL:DWTR? Check out the first part of my 3 part series on Tiktok that talks all about CDs!
What is a certificate of deposit (CD)?
A certificate of deposit (CD) is when the depositor agrees to leave a certain amount of money in the bank for a certain period of time in exchange for a predetermined interest rate provided by the bank. Once the depositor purchases a certificate of deposit, they cannot access the principal until the date of maturity of the CD. For example, if I purchased a CD for 1-year for $100 at a 5% rate, at the end of the 1 year, I will receive my $100 back and $5 in interest. But during the 1 year, I cannot access the $100 that I deposited into this CD. It has to stay in that account.
Banks or credit unions typically offer CDs for people to purchase.
What are the positives and negatives of investing in CDs?
One of the big positives is that CDs are a safe investment. There isn't really risk involved in purchasing CDs as the principal is guaranteed to be returned after the maturity date in addition to the interest you receive. It is one of the best risk-averse investments one can make since you virtually cannot lose with a CD (if you carry it through to maturity).
Another positive is that in the event of death or disability, banks will generally waive the penalty fee if you or your beneficiary need to withdraw from the CD. This is not always the case, so make sure that you read the fine print of the CD you are looking to purchase!
There is one big negative when investing in CDs. The first is that you will incur a penalty if you decide to withdraw or cash out of your CD prior to the maturity date (outside of the circumstances mentioned above). You technically committed to keeping a principal amount for a certain period of time, if you withdraw early, the penalty is usually a reduction in the amount of interest you receive. This varies by bank and by credit union so make sure you read the fine print before you purchase a CD. If the amount you owe in a penalty is greater than the accrued interest, the difference may come out of your principal, which will then hurt your interest earned for the remaining timeframe.
Another downside is that interest rates for CDs do fluctuate and change over time. When you purchase a CD, it could be a time when interest rates are low and you're locked into something that is .6% interest rate for a 1 year term. But if the Federal Reserve raises interest rates next month and new CDs are available with a 1% interest rate, you missed out. There are strategies out there that can help to maximize the interest you're receiving so you don't get that feeling of missing out (see the strategy section for more).
How do you invest in CDs?
Simply visit a bank or a credit union's website to learn more about their CD offerings. Most banks (traditional or online only) offer options for CDs. To invest, simply open up an account with the bank or credit union. Make sure you compare rates and terms before you commit. Even if you have the bank or credit union identified, they offer several CD options to choose from! Here are a few banks to look at and compare:
How much should you invest in CDs?
Depending on the bank and credit union, there may be minimum deposits required. Most do not have any minimum deposits, which make it easy for anyone to invest in a CD, but there are exceptions to this rule. For example, all jumbo CDs typically require at least a $100,000 deposit in exchange for a higher interest rate. But again, there are options out there that do not require a minimum deposit.
How much you invest in CDs depends on your strategy. If you're very risk averse, this is a great strategy as there is not much risk involved. If you wanted to, you could put a portion of your money into long term CDs and the rest in a high interest savings account. Much of the shorter term CDs have very similar interest rates as high interest savings accounts, but the latter is better since there aren't restrictions on withdrawing your money. Read up on the other benefits of having a high interest savings accounts.
When do you invest in CDs?
You can invest in CDs at any time! There isn't really a "best" time to invest in CDs, although it's always better to invest when interest rates are high as your returns will be higher.
Right now, it is 2/21/2022 and there are rumors the Fed will increase interest rates in March. If they do, that will increase the interest rates for CDs. I would personally wait until after the Fed announces as there's a high probability you will be able to lock in a higher rate. Knowing that interest rates can increase several times this year, you may want to invest in a shorter term CD to try and maximize the interest earned (or you can invest in a bump-up CD or step-up CD to get this benefit).
What are the best CDs to invest in?
The best CDs to invest in will depend on your strategy, how long you can keep a CD for and how much you want to access your money.
High yield CDs are great ones to invest in as many banks and credit unions offer this with no minimum deposit and typically offer a higher interest rate over a longer term.
A bump-up CD or step-up CD are also good options as you have the option to increase your interest rate over the course of the term length of the CD. Usually, these do require a longer term length compared to other CDs.
Jumbo CDs are great options for those who have a lot of money. As mentioned before, they typically require a $100,000 deposit. You get higher interest rates, but you have to deposit more money.
No-penalty CDs are another option for those who might need to withdraw money prior to the term length ending. Interest rates for no-penalty CDs are lower since withdrawal rules are more lax. If you really think you'll access your funds before the maturity date, it is better to keep your money in a high interest savings account rather than a CD.
What strategies are there for investing in CDs?
Laddering CDs is typically the most popular strategy for investing in CDs. This is when you invest a smaller amount in multiple CDs that range over a longer period of time. So instead of investing $5,000 in a 5-year CD, you would invest $1,000 in a 1-year CD, 2-year CD, 3-year CD, 4-year CD and a 5-year CD each. Once the 1-year CD matures, you would reinvest the $1,000 into a new 5-year CD to keep building upon the ladder.
By using this strategy, you are able to give yourself some flexibility since you can access a portion of your money when it reaches the maturity date each year and choose to reinvest it or use the money for something else. This strategy also allows you to diversify your interest rates in case they change over a period of time. If you locked in $5,000 in a 5-year CD at .5% interest rate, but the Fed raises interest rates in 1 year, you won't be able to take advantage of this increase. However, if you followed the laddering strategy above, you would have been able to reinvest the $1,000 1-year CD into a $1,000 5-year CD with a much higher interest rate.
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