Who Offers CDs?
Takeaways
- CDs are considered safer and lower-risk investments than stocks or bonds.
- A CD is a savings account with a set interest rate and term.
- You agree to let the bank use your money for a predetermined period with a CD.
- Withdrawing your money before the CD term has expired can trigger penalty fees.
- CDs are productive investments for excess cash when CDs are higher yielding than other saving options.
Not sure where to put excess cash? There are plenty of ways to earn interest income without taking on high levels of investment risk. If you don’t want to invest in the stock market, you can still store your cash in lower-risk investments that offer reasonable yields. Certificates of Deposits, or CDs, are savings accounts offered by banks and credit unions that many investors utilize when they don’t need access to excess cash for an extended period.
What is a Certificate of Deposit?
A certificate of deposit (CD) is a type of savings account offered by many banks and credit unions. A CD requires you to set aside a certain amount of money until a set maturity date. Depending on the bank, CDs have different minimum balances, and ranges of term lengths typically vary from three months to five years. During your CD’s term length, you will earn a variable or fixed interest rate depending on the CD.
CDs are essentially a loan from you to the bank. In exchange for the bank using your funds, you are compensated for deferring the use of your excess cash funds.
How Does a CD Work?
Setting up a CD can be completed in minutes, but it is vital to know how a CD works so that you are prepared throughout the process. Here is an outline of how to go about setting up an account:
Research Your Options: A variety of banks and credit unions offer highly competitive rates for CDs. Research your options and conduct due diligence on the bank and credit union where you might want to invest your excess cash.
Apply For Your Account: Most banks allow you to apply for your CD account online. You can also apply in person. If you are using a bank or credit union where you have another type of savings account or product, the process will be very straightforward. Opening an account usually only takes one to three business days.
Fund Your Account: Once your account is open for business, you can make your one-time deposit. You will start earning interest income almost immediately, and your account, depending on your bank, will be credited monthly. You can watch your funds grow throughout the life of your CD.
Wait for Term Maturity: The great part about investing in a savings account like a CD is that all the work is done on the front end of the transaction. Unlike investments in stocks or bonds, your CD’s value won’t fluctuate with changes in interest rates. CDs capitalize on a set-it-and-forget-it type of investing approach.
Typical CD Terms
Opening a new CD account (discussed above) involves several analogous steps to opening a new savings account, with a few exceptions. The main difference between a CD and a savings account is that you agree to part ways with your cash for a defined amount of time. Here are the four variables to consider when analyzing various CDs.
Principal: This is the amount of money you will deposit when you open your CD. You won’t be able to add funds to your CD after you have signed on the dotted line. If you want to invest more funds into a CD, you can create a CD ladder (described below).
Interest Rate: The interest rate provided by a CD is locked up front. Investors love this feature because it gives predictable returns for a defined period (which is relatively uncommon in investing). CD rates are expressed in annual percentage yield (APY). APY is the annual interest rate after factoring in compounding. CDs typically credit your account monthly to show interest income earnings.
Term: Like with a bond, CDs come prepackaged with various terms. A CD’s term is the time you agree to keep your deposited funds with the bank or credit union. These terms vary from 3 months to 5 years. On the maturity date of your CD (or when the CD ends), you can freely withdraw your funds without penalty.
Institution: Where you open your CD will determine certain aspects of your CDs, such as early withdrawal penalties and automatic reinvestment policies. Some banks or credit unions only allow you to withdraw funds for a week before automatically redeploying your cash.
When to Open a CD
Certificates of deposits offer investors safe and more long-term oriented savings vehicles. You can lock in interest rates for a predetermined time and know interest income is all but guaranteed (federally insured by the FDIC). Here are two practical reasons to consider investing in CDs:
Protect Savings: Building up a savings fund can take dedication and time. The last thing you want to do is lose your nest egg in a frivolous investment. Investors flock to CDs because they are a haven for savings and your financial base. Mitigating losses is a smart financial decision. CDs offer a perfect place to store your funds momentarily.
Guaranteed Returns: With a safe environment for your savings secured, investors turn to the highest place to earn a return on their money. While a high-yield savings account could be a good option, CDs typically offer higher yields. By investing in an FDIC-insured account, you protect yourself and enjoy guaranteed returns.
CDs can also be ideal for storing cash for larger savings goals that may take a while. Here are several practical use cases for investing in CDs:
Slush Fund: Once you have saved the $1,000-$3,000 emergency fund recommended by financial professionals, you might have excess cash savings that you do not need immediately. This surplus should fuel your slush fund or three to six months of living expenses. However, since you are saving away this cash for later, the smart money move is to earn interest on these funds and help them grow. Investing in shorter-term CDs could make perfect sense.
Wedding Fund: People plan for their wedding years in advance, and the wedding industry has boomed over the past several decades. Wedding prices have skyrocketed, and affording your big day will take some planning. Stashing your wedding fund into a CD could help you earn more money toward your wedding day, and the interest income can help fund expenses.
Down Payment Fund: First-time home buyers know that the process of saving for a down payment is a massive barrier to entry into the housing market. Down payments cost thousands of dollars, and if you are utilizing a jumbo loan or conventional loan you will probably need a down payment equivalent to 20% of the purchase price. Investing in a CD can help accelerate meeting the down payment goal.
Car Fund: Whether you are looking to buy a new or used car, prices have increased dramatically over the past several years. To keep ahead of inflation and surging prices, investing in a CD can help you hedge against continuous pricing increases.
Can I Add Money to My CD?
Unlike high-yield savings accounts, CDs do not let you continuously or regularly add funds to your account. Instead, you make a one-time deposit and keep the funds in the CD until your maturity date. If you want to deploy more capital into a CD, you make another investment in a CD with your new funds.
Who Offers CDs?
Your bank or credit union might already offer CDs for you to invest in. But if you want to get one of the best rates in the market, it might mean opening an account with a new institution like an online bank. Depending on the interest rate, moving funds to a new bank can be worth the effort.
How Are CDs Different From Savings Accounts?
A high-yield savings account and a CD have many similar features, including the fact that both earn interest on deposits and are great short-term places to park your cash. However, a CD is different from a savings account in several ways, including:
CDs don’t allow regular access to funds; savings accounts do: Once you deposit your funds into a CD, you can’t access those funds until the maturity date of the CD. If you want access to your funds, you will pay a penalty fee (more on that below). With savings accounts, however, you can freely add and withdraw funds at your discretion.
Interest rates on CDs are fixed; savings account interest rates fluctuate: Most CDs have a guaranteed interest rate associated with the account. There are exceptions to this rule, such as the bump-up or step-up CD, but most CDs are fixed. Investors are attracted to CDs for precisely this reason. This contrasts with savings accounts, even high-yield savings accounts, where interest rates change over time.
CDs have higher interest rates than savings accounts: CDs provide investors with higher interest rates because investors are parting with their cash during the investment term. Banks and credit unions offer higher interest rates than regular savings accounts to compensate investors for this risk. Once the term ends for your CD, you have several days to withdraw your CD without penalty.
What is a CD Ladder?
A CD ladder is an investing strategy that involves opening short-term and long-term CDs in a staggered manner. Instead of putting all your cash into one CD, you spread funds over progressively longer CDs, capturing interest rate spreads.
Here’s how to build a CD ladder: Imagine you have $5,000 to invest in CDs, but you want access to a certain percentage of your funds and to take advantage of changing interest rates. You would invest $1,000 each in a one-year, two-year, three-year, four-year, and five-year CD. This could allow you to capture today’s interest rates spanning from one to five CDs. After the one-year CD matures, you reinvest that $1,000 into a new five-year CD and repeat the process as your CDs mature (always with the $5,000 spread over five tranches of CD maturities).
Are CDs Insured?
The safety of CDs is what attracts most investors. As a facilitator of that safety, the Federal Deposit Insurance Corporation, or FDIC, guarantees certificates of deposit per institution up to $250,000. Even if the bank or credit union fails, you will be able to receive your money. This is what makes investing in a CD a core part of building your base investing strategy.
Smart Summary
Certificate of deposits can be terrific shorter-term investments that shield your money from stock market volatility. They are an easily accessible option if you are looking to earn interest income and save money when you won’t immediately need access to these funds. Diversifying your savings is a smart money move and certificates of deposit can be an integral part of your overall investing strategy.
Frequently Asked Questions
We don’t recommend stashing your emergency fund in a CD because you want your emergency fund to be highly liquid. With a CD you might incur early withdrawal penalties.
The Federal Reserve sets interest rates which flow through to the economy via the banking system. When interest rates rise, so does the interest you earn on your money in savings accounts and CDs.
If you are looking for a haven for your cash with low risk and high returns (in a high-interest rate environment), a CD could be a good investment for you. Investing in the stock market typically generates higher returns, but the risk of investment is significantly higher.
