Pros and Cons of Investing in CDs
Certificate of deposits (CDs), which are also called time deposits, are interest-bearing deposit accounts that guarantee a specific rate of return. Interest rates on CDs surpass those of saving accounts because the investors commit to a specific time period where they will not withdraw the investment or else have to pay substantial early withdrawal penalties. Such terms can range from 30 days to 5 years, and they generally offer a higher rate of return than most secure, comparable investments such as checking and savings accounts.
Benefits of CDs
There are clear benefits of opening a CD. First, CDs generate a higher return than checking and saving accounts. In addition, they lack the volatility and risks that are associated with investments such as stocks and annuities. Next, CDs are virtually all insured, though it is pragmatic for the owner to verify his CD is either FDIC insured with banks or NCUSIF insured with credit unions. As of 2009, these CD investments are secured up to $250,000 should the institution fail. Finally, CD’s are virtually risk-free and the owner will get a pre-calculated rate of turn regardless of changing interest rates and if the bank goes under.
Drawbacks
While there are clear benefits to opening a CD, the investor should also be aware of its costs. First, a CD will not give the owner substantial returns compared to other kinds of security investments. While CDs offer steady interest rates, they usually do not produce high returns, as they are essentially used as a short-term, low-risk investment where the owner can search for a more profitable venture to invest in. While the risk is small, so too is the likely profit.
Should investors wish to avoid the lower rates of return that come with short term CDs, they can invest in longer term ones for a higher rate. However, the investors then take on the risk that interest rates could go up during this term, resulting in the investor being stuck with a low-interest rate until it matures.
As mentioned earlier, CDs also bring with them substantial withdrawal penalties. Not only can investors lose some if not all of the CD interest when making early withdrawals, but some may also lose part of their principal investment.
What to look for
To get the most out of a CD, the owner must compare rates between banks and credit unions. Shopping around for highest rates is standard to ensure the owner gets the most for his money. Additionally, a potential owner who does not have much money to invest and will need some in the near future should strongly consider purchasing short term CDs. Despite the likely smaller profit, a CD will still grant the owner a better rate of return than a savings or checking account in that time period. It is far more pragmatic for these individuals to tie up their money for only a few months rather than four or five years as they look for a better investment.
Finally, CD owners should research their investment and seek for ways of relocking their CD at a higher interest rate, should they rise during the CDs term. For example, some banks offer CDs where the owner can relock into a higher rate one time should the interest rates go up. It is important that the investor is aware of this and learn the procedure for relocking into a higher rate so he can make a higher profit. While the consumer generally will not receive a completely identical increase as high as the interest rate, it is still important the owner is cognizant of this potential.
