Investing with Certificates of Deposit (CDs) Explained
Certificates of Deposit (CDs) are deposit accounts that offer a fixed rate of return over a set period. These accounts, commonly offered by FDIC-insured banks or NCUA-insured credit unions, provide principal protection up to $250,000 per depositor per institution.
CDs come with various terms, including 6-month, 1-year, 3-year, 5-year, and even longer options. A CD ladder strategy can be employed to optimize returns while maintaining some liquidity. This strategy involves investing in CDs with varying terms that mature around the same time, allowing investors to achieve a specific goal by a certain date.
There are several types of CDs available. A traditional CD offers a fixed interest rate for the term of the deposit. A no-penalty CD allows for withdrawals before maturity without incurring an early withdrawal penalty, but typically offers slightly lower rates than traditional CDs. A step-up CD is similar to a bump-up CD, but the bank automatically increases the rate at predetermined intervals. A bump-up CD gives the depositor the option to request a rate increase a certain number of times during the term. A callable CD gives the bank the power to close out the CD, potentially offering higher rates but with the risk of being closed prematurely. An add-on CD functions like a standard savings account, allowing for additional deposits to the principal.
CD rates can be found and compared online, and a CD calculator can be used to project earnings. It's important to note that inflation can outpace the yield of a CD, causing the money to lose purchasing power over time, even as the nominal value increases.
The advantages of using a CD laddering strategy include providing regular access to funds due to staggered maturity dates, reducing interest rate risk by not locking all money in one long-term CD, and enabling reinvestment at potentially higher rates as CDs mature over time. It also offers flexibility to adjust investments based on changing interest rates and can improve overall yield compared to continuously rolling over a single CD.
However, CD investments involve relatively lower liquidity compared to savings accounts, as the funds remain locked until each CD matures. If interest rates fall significantly, reinvesting maturing CDs may result in lower returns. Additionally, managing multiple CDs requires ongoing monitoring and decision-making about reinvestment or withdrawal. Lastly, the overall yield might still be lower than more aggressive investments, and penalties apply for early withdrawals from CDs if needed before maturity.
Early withdrawal penalties can eat into the earnings and possibly the principal of a CD, so it is important to only open CDs with money that can be committed to remaining untouched for the full term. Jumbo CDs require a minimum deposit of $100,000 and may offer slightly higher rates than standard CDs.
In 2025, despite rate cuts, CDs with yields outpacing the current inflation rate of 2.4 percent can still be found. It's always a good idea to compare CD rates and strategies to find the best fit for your financial goals.
[1] Source: Bankrate.com [3] Source: Investopedia.com [4] Source: Forbes.com
- If you're looking to diversify your financial portfolio, consider opening both savings accounts and money market accounts, as well as investigating CDs, which offer principal protection and can be a part of a CD ladder strategy for optimization.
- Beyond CDs, it's essential to understand various aspects of personal-finance, such as engaging in smart investing to grow your wealth, while also considering the potential impact of inflation on your money market accounts, savings accounts, and investments.
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