This is a valid question and in the current interest rate environment it’s fairly easy to make the case that CD’s although very safe do not offer very high yields. However as interest rates rise it could be a choice to consider for higher yields. While we’re here let’s go over what CD’s are and some options available to this safe product.
What is a Certificate of Deposit (CD)?
A CD is a low-risk and low-return investment sold by banks and credit unions. These are a good place to invest money for a short amount of time that is safe and will allow your money to grow slowly. These are perhaps the safest way to earn money as you are guaranteed to get the full amount you put in back, plus the interest at the maturity date. It normally requires at least $500 in order to purchase a CD and it is highly suggested you purchase from a bank insured through the FDIC or a credit union insured through NCUA. This is your guarantee that no matter what happens to the economy, you will get your full investment plus the interest returned to you. The interest rate is slightly higher than what you would make in a savings or money market account as you agree to leave the money until the specified time lapses. The CD terms are generally from three months to five years. This means you don’t have access to the funds without paying a penalty. The longer term will yield the higher interest rates, but will keep you from those funds for a longer time.
What are the different types of CDs?
The typical or traditional CD is one with a fixed term at a fixed interest rate. This is the most common, however there are other choices:
*Add-on CDs allows you to make additional deposits to a fixed or variable CD during the term.
* Callable CDs give the bank the option to ‘call’ or buy back the CD after a set time before the term ends.
* Zero-coupon CDs pays the interest only at the end of the term and does not allow the option to withdraw just the interest.
* Variable CDs pays an interest rate based on the index set by the Treasury or prime rate bill.
* Bump-up CDs gives you a fixed interest rate with the choice of increasing it one time during the term of the CD. This is good way to take of advantage of interest rates should they increase.
* Jumbo CDs require you to invest at least $100,000 and normally offer the higher rate of interest.
* Liquid or No-penalty CD will allow you to withdraw a portion or your money without being charged a penalty.
What is the difference on interest between APY or APR?
CDs can accumulate interest in two ways. The annual percentage yield (APY) is the rate you will receive if all the interest is added back to your balance and you don’t withdraw the interest earned. The annual percentage rate (APR) is the rate of interest you will earn if you plan to take the interest amount you’ve earned out and do not let it compound to your initial deposit balance.
When is a good time to buy a CD?
A short term CD is a good option if you plan to spend the balance after it matures on something you are savings for such as a house or a planned vacation. It would be a good idea to research interest rates on high-yield savings account or money market accounts as they may pay interest rates that much like the CD. You will then also have access to the funds should you need it. If you have a large amount of money you want to invest such as retirement funds or a child’s tuition, then a longer term CD would be a better investment as you can get the higher interest rates.
With the current economic status, the Federal Reserve will keep federal fund interest rates low through 2015. This is good for mortgage and bank loan rates; however it is not as good for savings account interest rates or CD interest rates. Consumers have been using more online banks which offer high interest savings accounts. One of the high yield savings account that anyone can open online is the American Express savings (Amex savings) which is offering 0.90% APY. The setback to high-yield savings account is that the same interest rate is not guaranteed forever; a bank can raise or lower it depending on current economics.
It is always a struggle to try and save money and having to balance risk with reward can be the biggest struggle. The guarantee of a CD makes it a much safer way to protect your funds and know they will be there at the time you’ve chosen.