Certificates of deposit, or CDs, are a great low-risk way to build wealth and a solid alternative to savings accounts for short- to mid-term investments. Here's some background about how they work and whether they could be a good fit for you.
A certificate of deposit, or what credit unions call a share certificate, is a way to grow money you don't need immediately and that you aren't using to invest for retirement. When you open a CD, access to your money is restricted for a set period of time. In exchange for leaving your money with the bank, you are rewarded with a higher interest rate than what's offered on checking accounts as well as most savings accounts.
The longer the term of your certificate of deposit, the more interest you earn on your money.
A CD almost always earns a higher interest rate than a typical savings account. Also, you'll know your money is safe because the Federal Deposit Insurance Corporation (FDIC), or the National Credit Union Administration, insures your CD up to $250,000.
Typically, CD terms range from three months to five years, although the length of some is as long as 10 years. Some of the best CDs offer an annual percentage yield of 2% or more for a six-month term and rates of 3% or higher for a three-to-five year term.
Certificates of deposit are a more lucrative and still safe option for your savings. Since your returns, though moderate, are guaranteed, CDs can be a good complement to your retirement accounts and your checking account.
If you withdraw your money before the maturity date, when the term is up, you have to pay a small penalty, so you shouldn't put money in a CD that you might actually need for something else. A CD isn't a good place for your emergency fund, for example. Since you probably won't earn as much with a CD as you would with your 401(k) or IRA, CDs aren't a great place to put your retirement savings, either.
But if you feel reasonably certain that you won't need the funds in the short term, then a CD is a safe option for guaranteed growth.
CDs are ideal for savers who have enough cash to put some of it away for years at a time and want a guaranteed, moderate return. It's best to consider a CD after you have already saved enough easily accessible cash for an emergency fund, typically enough to support your living expenses for three to six months.
Usually, you need a minimum deposit of $500 or $1,000 to open a CD. If you're not able to invest that much, consider a high-yield savings account. You can sometimes get rates that are about as a high as a CD, only with more flexibility.
Overall, a CD is a low-risk way to grow the money you're not using and don't immediately need. As long as you avoid withdrawing your cash early, you can get a solid return on your money, while also keeping it safe.
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