Have you heard the phrase CD or certificate of deposit and wondered, what is a certificate of deposit, and how can it help me secure my financial future? We’ll explain what you need to know so you can decide whether a certificate of deposit (CD) is right for you. Here’s a brief overview of what CDs are, how they work, and when might be a good time to open one.
What Is a Certificate of Deposit?
A CD is similar to a savings account, but it operates a little differently. Just like a savings account, a CD accrues interest. However, unlike a savings account, you typically are unable to withdraw your money for a specified period, known as the term. While you can withdraw your money early if necessary, you will usually be charged a penalty for doing so. At the end of the term, you receive your investment back plus the accrued interest.
Advantages of CDs
What are the benefits of opening a CD when they come with so many rules, you’re asking? Well, they tend to earn money more quickly than a traditional savings account. In fact, Fortune Recommends reported earlier this year that CD rates are at a three-year high and that now could very well be the time to buy.
Another benefit of opening a CD is that while investing in the stock market could earn you money more quickly, it also carries more risk. For those who are more risk-averse, opening a CD provides a good opportunity to grow your money quickly while avoiding the risk often associated with investing.
Drawbacks of CDs
A major drawback of CDs, for some, is that you’re unable to access your cash for a certain period of time. CDs vary in length—shorter ones may last only a few months, while longer ones may last up to five years or more. Typically, the longer the term, the higher the interest rate. But keep in mind that for the duration of the term, you’ll be unable to withdraw any funds.
What happens if an emergency pops up? If you have a financial emergency and need to access the money in your CD, you still can, but you’ll typically be hit with a penalty. The penalty amount is usually reflected as a set period of interest, though it may also be expressed as a dollar amount. How much you’ll be charged for an early withdrawal depends on your financial institution as well as your CD term. This penalty could negate the interest you have accrued. In fact, the early withdrawal penalty may even cause you to lose money on your opening deposit.
Also, once you deposit your lump sum to open the CD, you’ll be unable to make any additional deposits. So you’ll be limited to accruing interest only on the initial amount you deposited into the account.
What to Consider Before Opening a CD
You should ask yourself a few questions before opening a CD:
Do I Have an Emergency Fund?
If you do not have an emergency fund, you should build one prior to opening a CD. If something pops up unexpectedly and you do not have any emergency savings, you’ll likely be tempted to withdraw money from your CD and have to pay the penalty. Before opening a CD, it’s a good idea to build a financial safety net.
Many experts recommend saving three to six months’ worth of living expenses. However, it can vary depending on your particular situation. For instance, a married couple with two incomes will likely need to save less than a single person with dependents. Once you have a comfortable amount saved, you can consider stocking away extra funds in a CD.
What Term Should I Select?
Generally speaking, the longer the CD term, the higher your interest rate. If you’re looking to earn the highest interest rate possible, you may want to select a longer term. But keep in mind that you won’t be able to access the money during that time without incurring an early withdrawal penalty. It’s important to think about whether you’ll need to access your funds any sooner than that and select the term you feel would work best.
Is Now the Right Time?
There’s an old adage that timing is everything, and CDs are no exception. Your interest rate for a CD will be locked in for the full term, so it’s important to open a CD when you’re most likely to get the best interest rate.
Where Should I Open My CD?
If you’ve decided that opening a CD is the right financial move for you, the next step to consider is where to open one. Many banks and credit unions offer CDs, but you’ll typically find that your community credit union offers more competitive interest rates, as well as a range of member benefits you’re unlikely to find through a bank.
Find a CD option that offers the term you’re looking for and the most competitive interest rate. Some options may have a minimum deposit requirement, so know how much you plan to deposit so you can choose a CD that fits your needs and financial goals.
For instance, Capital Credit Union offers a couple of certificate options. They understand that personal finances don’t come in a one-size-fits-all formula and offer both share certificates and member’s choice certificates. The member’s choice certificate, for example, only requires a $1 deposit, earns dividends over a 12-month term, and provides flexibility with the option of a one-time penalty free withdrawal.
Financial success doesn’t have to be difficult. With a little bit of knowledge and the right financial moves, you can manage your money confidently and watch your funds grow.