Saving money helps you build financial security. But some accounts help you build more security than others. A certificate of deposit might be a good way for you to earn money with the money you’ve saved.
What They Are
A certificate of deposit, or CD, is a savings account, but it has special features that ordinary savings accounts don’t have.
With a CD, you deposit a minimum amount of money into the account. Some require $500, while others require $2,500 or more. Unlike a savings account, you also deposit that money for a certain amount of time, or term. Some CDs have a term of one year, but many others are much shorter or longer. This brings up the key difference between CDs and savings accounts: If you withdraw money before the CD’s term is up, you’ll have to pay a penalty. Penalties vary, but sometimes the penalty is giving up some of your interest earnings — as much as three or six months’ worth.
Once you deposit your money, it begins earning interest. Imagine you have a CD with a minimum balance of $1,000, a 2.5 percent interest rate and a minimum term of one year. The amount you earn — probably a little more than $25 — is added to the account during the year. At the end of that year, the CD matures. Now you have a choice to make: You can withdraw the money, or you can reinvest in another CD.
Why a CD May Be Right for You
CDs might be a good choice if you have some money that you’re unlikely to need soon. That’s because CDs are generally low-risk. (It’s a good idea to make sure the bank that issues them is FDIC insured.) They usually offer higher interest rates than traditional savings accounts.
The longer you leave money in an interest-bearing account, the more money you make. That’s another advantage of CDs — you can park your money there for a long time, and you may get higher interest rates on longer-term CDs than the short-term ones. So, if you know you won’t need the sum for a long time and you want to make money on it, a CD might be right for you.
Another benefit of a CD is that long-term savings prevents you from spending money that you want to save. For those that have a tough time not touching their money, this is a great option to avoid that temptation.
Other Things to Consider
Nobody can predict their financial future, of course. What if you might need a new car soon? Or perhaps one of your children is considering going to college. If you might need access to your money, a CD may be too inflexible for you.
Some CDs have much shorter terms, fortunately, such as three months or six months. If you can’t be sure whether you will need that money, these CDs might be a good option. But keep in mind that often the shorter-term accounts offer lower interest rates than longer-term options.
Some people use more than one CD when they need more flexibility. They might deposit a certain amount of money in a new CD every year for five years, oftentimes referred to as CD laddering. This way, they have one account maturing each year and a chance to access at least part of their funds without paying a penalty.