4 Benefits of a Certificate of Deposit (CD)

If you’re looking for a secure way to grow your money, a CD could be right for you.

Are you on the hunt for a secure way to grow your money? Although it may not be on your radar, consider the benefits of a Certificate of Deposit (CD). In a nutshell, it is a deposit account with a set term, typically running anywhere from three months to 10 years. But more than that, a CD is designed to increase your savings because regardless of what the market does, money you put into a certificate of deposit grows thanks to its superpower: interest.

There are many benefits of a certificate of deposit

If a certificate of deposit sounds like something that could do wonders for your financial plan, you’ve come to the right place. Here are four benefits of a CD:

1. CDs can be a safe choice

Are you skittish about betting on the stock market or tying up your money in more volatile products such as bonds? A benefit of a certificate of deposit is that it can lay many of those fears to rest. That’s because the FDIC insures CDs up to the maximum allowed by law. Before you open a certificate of deposit, confirm that your financial institution is FDIC insured so if it were to fail, you know your money is protected.

While having the FDIC on your side helps, CDs come with further protections. One of the main benefits of a CD is that unlike stocks, where it’s possible to gain or lose large sums all in one day of trading, money put into a CD will continue to grow predictably.

Andrew Denney, founder and CEO of financial planning firm Prosperity Financial Group, says that a CD can be secure because in some cases, you can “cash out and still get the principal.” However, while your initial deposit can be safe, if you cash out early, you may face an early withdrawal penalty that could eat into your interest. At times, these penalties could also impact your principal. (Skip to CD benefit #4 to learn more.)

CD benefits include locking in your rate and watching your money grow over time

2. CDs can have fixed rates for fixed terms

Financial markets can be volatile and returns for investments in the stock market or real estate, for example, can be unpredictable. Some years are fruitful and others are… less so. But another benefit of a CD is that you can lock in a fixed interest rate for the life of the product. Unlike the sometimes roller coaster fluctuations of the markets, a CD grows dependably courtesy of slow, steady interest.

When you weigh the benefits of a certificate of deposit, there are three interest rate options to consider:

  • A fixed-rate CD has a set interest rate that is paid throughout the life of the CD. A 5-year CD with a 2.00% APY (annual percentage yield) will earn that rate for the entire term, regardless of any interest rate increases or decreases during the time you have the CD.
  • A variable-rate CD typically pays a percentage according to the difference between the interest rates at the beginning and end of your CD’s term. For example, if you opened a 2-year variable-rate CD at 1.05% APY and it grew to 1.15% APY, your return would be calculated based on the increase over that time period.
  • An adjustable-rate CD has a set interest rate at the time of your deposit but comes with the option to “adjust” the rate during the CD’s term (you may only be able to adjust the rate a limited number of times).

Alexander Joyce, president and CEO of ReJoyce Financial, LLC, a retirement income planning firm, says that although they are less liquid, an important CD benefit is the fixed interest. If you opt for a longer-term CD, such as one with a 3-to-5-year term, the interest rate could be higher, Joyce adds. Depending on the financial institution where you open your account, and how long you want to keep your money in a CD, it is possible to find rates advantageous for both short and long terms.

3. CDs come with different maturity dates

Have you dreamed about soon taking the trip of a lifetime, or are you saving for something further out, like higher education for a child just learning the multiplication tables? Among the key CD benefits is that it can provide a safe place to park your funds for a set period that’s aligned with your financial goals.

Randy Becker, a retirement planning professional and owner of Becker Retirement Group, says a benefit of a CD is that it can help you save for large, one-time expenses. If, for example, you plan to take a costly vacation in the future, you can put your funds in a CD that matures right before you leave. “You can match your CD to the timing of life events,” Becker says.

4. CDs may have low or no fees

Another benefit of a certificate of deposit is that it may have a low-to-no fee structure. Some banks don’t charge a monthly fee to hold your money in a CD. This comes in handy, according to Joyce, because you don’t have to worry about fees impacting your CD earnings.

A simple way to reach your goals.

Watch your savings grow with a CD.

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While the absence of a monthly fee is a key CD benefit, it’s important to remember that there could be other costs associated with a certificate of deposit. One example is the early withdrawal penalty (remember this?). Should you take your money out of the account before its maturity date, the bank may impose a penalty, which could negatively impact your interest or principal.

An early withdrawal penalty and account fees depend on the agreement at the time you open the account, so make sure you read the fine print and have a clear picture of what fees and penalties, if any, apply. Some banks offer no-penalty CDs, so it might be useful to inquire about these, too.

The benefits of a CD include guaranteed growth and security

Making wise financial decisions

While CDs currently offer a leaner interest rate compared to robust rates of cycles past, don’t be discouraged. The benefits of a certificate of deposit are many, including safety, low-to-no fees and, in some cases, flexible maturity dates. These CD benefits can provide invaluable peace of mind when it comes to your money. And, Joyce says, sometimes the potential gains in an uncertain market don’t outweigh the need for a financial product like a CD that provides reliable growth.

“Feel secure about that,” he says.

Source: discover.com

Step Up Your Savings Game With a CD Ladder

Want to build your nest egg while avoiding risky investments? Learn how with a CD ladder.

So you don’t have a money tree planted in the backyard, and you’re not sitting comfortably and carefree, cool drink in hand, watching that money grow. Instead, you’ve got to work and earn and actively manage your money in order to build the nest egg that will eventually let you enjoy that backyard moment with ease. Alas…

Still, there is one way to earn money with your savings without making a risky financial move. It’s called a CD ladder, and it may be as close as you can get to watching that backyard money tree grow. Using a CD ladder, you can earn a predictable return on your savings and take advantage of potentially higher interest rates as you climb the ladder’s rungs.

Build a CD ladder to help you save more in the long run

When considering a certificate of deposit (or CD) as a savings vehicle, two risks often come up: The risk that you’ll need the money when it’s locked up (liquidity risk) and the risk that interest rates will rise and leave your savings tied up in a CD earning below-market returns (interest-rate risk). But if you create a CD ladder, you may be able to mitigate both of these risks.

A CD ladder: Defined

A CD ladder is a series of CDs that are set to mature (complete their term) at regular intervals. “It’s easy to set up,” says Jonda Lowe, president of financial services firm JondaKnows in Huntington, West Virginia.

Lowe gives an example of how to build a five-year CD ladder with five $20,000 CDs. Initially, the ladder would look like this:

  • $20,000 in a 12-month CD
  • $20,000 in a 24-month CD
  • $20,000 in a 36-month CD
  • $20,000 in a 48-month CD
  • $20,000 in a 60-month CD

Each year one of the above CDs will mature, and at that point you can either withdraw the money or put it into a new five-year CD. The second option keeps the CD ladder going so the money continues to earn interest.

A CD ladder helps you build wealth by harnessing the power of compounding interest

If you build a CD ladder modeled from Lowe’s and open new 60-month CDs as the original CDs mature, after four years your ladder will consist of five, five-year CDs. This is the sweet spot: You are earning the higher interest rates common to longer-term CDs but with regular access to your money, and you are positioned to take advantage of higher interest rates every year (if they’re available) as you open new CDs.

To that point, William Stack, owner of Stack Financial Services LLC in Salem, Missouri, says that CD ladders can be particularly advantageous in a rising interest rate environment. “By breaking large CDs into smaller ones maturing at different times, you can earn progressively higher interest rates as CDs mature,” he says.

opening CDs of varying terms. Many banks even let you complete the process online. If you need additional help, a banker or broker may be able to create a CD ladder for you.

To design your ladder, you’ll have to decide on the overall length of your ladder (or the duration of the longest-term CD) and the length of time between each CD’s maturity date.

While staggering maturity dates by one year is common (as modeled in the scenario above), you could set your CDs to mature at intervals of your choosing—every six months or two years, for example. Regardless of the length, when you create a CD ladder you’ll initially have to purchase shorter-term CDs, such as those with one- or two-year terms.

If you don’t expect to need the money on short notice, a less frequent maturity cycle could be appropriate when you create your CD ladder. However, if you need a portion of the money quickly (let’s say that a financial emergency hits), shorter maturity intervals would give you more frequent access to some of the funds and could spare you from an early withdrawal penalty.

Create a CD ladder to meet your goals

One of the great things about CD ladders is that they can come in all shapes and sizes. You can adjust the length, or term, of the CD ladder and the frequency by which it matures to match your financial goals, like building up your emergency savings or prepping for a big-ticket purchase.

Emergency fund

You can use a CD ladder as an emergency fund by structuring it to mature in monthly increments and putting an average month’s expenses in each CD. You can reopen CDs as they mature, or the bank may be able to automatically open them for you. Hopefully, emergencies rarely arise. But when one does, you’ll have a steady stream of maturing CDs to cover your expenses. That said, even if you use a CD ladder to save for emergencies, it may be worth setting aside at least a portion of your emergency stash in a checking account or savings account for quick access.

Create a CD ladder today to help you save for an emergency fund or large purchase

Big-ticket purchase

Your approach may be different when creating a CD ladder for a specific purchase. Perhaps you’re planning on buying a car in five years but you are not comfortable locking up all of your new-car savings for 60 months. You could build a CD ladder in the same way you would for more general savings outlined above, but when your CDs mature, you wouldn’t reopen five-year CDs. Instead, you would open CDs that mature within your savings time frame. If you are still four years away from the new set of wheels, for example, your new CD could have a 48-month term. If you are three years out, 36 months, and so on.

College expenses

You could also create a CD ladder to help cover college expenses and time it so that a CD will mature at the start of each semester or school year. Or, as your child nears college—perhaps three or five years out—you could build a CD ladder to help keep their education fund growing and secure.

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When determining how best to create a CD ladder to meet your financial goals, consider the current interest rate environment. For example, in an environment where interest rates are expected to drop, Stack says it might make more sense to lock in the current interest rate with long-term CDs than to create a CD ladder.

Lowe seconds this opinion. “When rates are expected to stall or drop, CD ladders can cost you money,” she says. In this scenario, each time one of your CDs matures and you put your funds back into a CD, you could be locking in a lower interest rate.

A CD ladder can help you save for a large, long-term goal

Finding your fit

A certificate of deposit can be a dependable financial tool that may work well if you’re looking for a low-risk way to save your money and earn a predictable return. However, locking your money up could mean taking on liquidity and interest-rate risk. Building a CD ladder can help boost your returns while limiting the potential drawbacks. So, while your fabled money tree is (sadly) unlikely to ever materialize, growing your money with a CD ladder is about as good a trade-off as they come.

Source: discover.com