CDs, or certificates of deposit, tie up your money for a set term. You must normally pay a penalty to withdraw it early. This lack of liquidity constitutes the main disadvantage of CDs. You can turn this factor to an advantage by using CDs to keep savings you don't need safely out of temptation's way. Whenever you want to keep money invested for a fixed time, CDs offer other advantages as well.
If you open your CD in a federally insured bank or credit union, you have $250,000 in insurance on CDs in your name alone. You can also open $250,000 in insured CDs in as many different banks or credit unions as you like. While other types of bank accounts also offer this insurance, money market mutual funds do not.
You usually earn a higher interest on savings you put in CDs compared to a regular savings account or even many money market accounts. In addition, unlike a money market account or money market mutual fund, the interest rate is fixed for the term of the CD if you keep your money invested.
You normally do not have to pay fees on CD accounts unless you cash them out early, in which case you pay a penalty. Some regular savings accounts charge a fee for exceeding the permissible withdrawals or for allowing the balance to fall too low. Fees on money market mutual funds also reduce your actual return on your investment.
You can increase the flexibility of your CD investment with "laddering." This means you invest portions of your money in several CDs with different maturity dates. For example, purchase five $5,000 CDs with maturities at one year, two years, and so on, up to five years. When each CD matures, you can cash it or roll it over for five years to keep the ladder going. In addition to giving you periodic access to some of your money, laddering allows you to keep some CDs invested at higher rates if rates fall. You can also take advantage of rising rates if you choose to roll over a CD that matures.
Savings institutions sometimes offer special CDs with other benefits. For example, some CDs allow you to add money, take money out or "bump up" the interest rate if market rates increase. Usually, however, banks only allow one "bump up" over the term of the CD. Another special CD is a zero-coupon CD. You buy a zero-coupon CD for less than the face value and receive face value when it matures, thus postponing federal tax liability. You can also get higher yields on CDs by purchasing them through a brokerage or by shopping for the best rates nationally online at Bankrate.com.
- Bankrate.com: Compare CDs With Other Investment Options
- Bankrate.com; Money Market Fund Investing; Don Taylor; July 1, 2005
- "Kiplinger"; Where to Stash Your Cash Now; Joan Goldwasser; February 2009
- Bankrate.com: Types of CDs
- "Making the Most of Your Money Now"; Jane Bryant Quinn; 2009
- Bankrate.com: Types of CDs
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