A certificate of deposit that is insured and is held until its maturity date cannot lose money. For this reason, CDs are considered one of the very safest and lowest-risk savings vehicles available. But, that said, you may not earn as much interest as you could elsewhere.
Let’s take a look at this topic more closely, so you can decide the best way to grow money that isn’t earmarked for your everyday bills. We’ll cover the following angles:
• What is a CD? How do CDs work?
• Can you lose money on a certificate of deposit?
• What are the pros and cons of CDs?
• When do CDs work best?
Now, it’s time to answer those important questions so you can grow your money in the way that best suits your needs.
What Is a Certificate of Deposit (CD)?
We’ll answer the question, “Is investing in CDs smart?” But first, how about the scoop on “What is a CD?” Allow us to define our basic terms. A certificate of deposit is a savings account offered by banks or credit unions that holds a certain amount of money for a fixed period of time. This time frame can typically range from six months to five years, but you might find even shorter- or longer-term products. There may be a minimum deposit amount, too, of possibly $1,000 or a similar sum.
In return for holding onto your hard-earned cash, the bank pays you interest over the term of the CD. At the end of your CD’s term (you may hear this referred to as when your CD matures), you receive the money you originally put in along with the interest earned from having your money locked away. CDs can be a more attractive savings vehicle than an ordinary savings account because they may offer higher annual percentage yields (APYs). Typically, the longer your money is in the CD, the higher the rates offered.
If you get a CD from a bank that is a member of the FDIC and insured by the Federal Deposit Insurance Corporation (FDIC), the CD can be insured for up to $250,000. This means that in the event the bank or credit union that holds your CD defaults, the money in your account will be protected. It’s worth noting that certificates of deposit are considered so safe and reliable that you may be able to use CDs to secure a loan.
Recommended: CD Loans, Explained
How Standard Certificate of Deposits Work
A CD is similar to a standard bank account, but the difference is CDs have a “lock-in” period where you cannot access the money during that time (the CD’s term). In exchange, you earn interest on the account.
When you open a CD you have to determine how long you are able to keep your money stowed away. This term length generally ranges from six months to several years. An important point: If you need to access the money before the term ends, you will usually pay a penalty for withdrawing the money before the account’s maturity. Think you might need to get your money out sooner? There are CDs that allow early withdrawal without penalties; these are typically called no-penalty certificates of deposit.
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Can You Lose Money on a CD?
The risk of having a CD is very low. Unlike the stock market or IRAs which can lose money, you cannot lose money in a CD. There is actually no risk the account owner incurs unless you withdraw money before the account reaches maturity. In this case, the early-withdrawal penalty could eat up some or all of the interest earned. In rare cases, it might take a bite out of your principal, too.
Pros of Investing in a CD
CDs can be a convenient way to grow your money. High-yield checking and savings accounts can be as well, though. Or perhaps you’re tempted by other investments and wonder how CDs vs. bonds perform. Let’s consider some of the benefits specific to certificates of deposit, so you can decide what will work best for you.
• Security. You can count on a CD for its safety. Make sure to open a CD from a federally insured bank or credit union so your money is in an insured financial institution.
• Dependability. Instead of having your money sit in a bank and not get any returns, with a CD, you can expect to get fixed returns from your CD deposit at a specific time.
• Flexible terms. When opening a CD, account holders get to select from a wide range of term lengths. If you prefer a CD with a shorter maturity date, you can choose a term of a month or two. Looking for a longer duration? Some CDs may be offered with a 10-year duration.
Cons of Investing in a CD
As with most financial products (and things in life), there are pluses and minuses to certificates of deposit. Here’s a look at the potential downsides of putting your money in a CD.
• Lack of access. Once you add money to a CD, you won’t be able to access it until the term is over. During this time, you are not able to add money either. That said, if you need the money for a big upcoming purchase within the next year, it’s probably best to stick with a CD with a shorter maturity date such as three months.
• Possible penalties. When you open a CD, you are making a commitment with a financial institution that you will not access that money until the CD matures. If you break that commitment and withdraw money from your CD prior to its maturity date, you will incur early CD withdrawal penalties. This could mean the financial institution withholds an amount of interest on the money you withdraw or could even take some of your principal. Unless you choose a no-penalty certificate of deposit, in which case you will not incur penalties.
• Low returns. Yields on a CD can be competitive but when comparing their returns to investing in the stock market, they’re relatively low. That said, remember that risk plays a role in the market. If you are wondering, “Can you lose money with an index fund or other investment?” keep in mind that the answer may well be “yes.” When you are investing in stocks and exchange-traded funds, investors take on additional risk and are compensated for that risk. But when putting money in a CD, you aren’t taking any risk, which means the returns are lower.
When CDs Work Best
CDs work best when you are able to put away money for a period of time and accumulate interest over the term. There are different scenarios in which a CD is a great option. Let’s take a look:
Saving for a Near-Future Purchase
If you are saving up for a big future purchase, such as a home or a car, you can put your money in a CD to protect it against inflation until you are ready to access those funds. At this moment, however, inflation rates are very high, so check rates carefully to find the best possible offer to keep pace.
Building Short-Term Wealth Before You Invest
If you are new to investing and want to build up your funds to have a more consistent strategy, a CD can help. You can use a short-term CD to steadily grow your cash position before you invest it in the stock market.
Ensuring Returns Without Stock Market Risk
For some, investing in the stock market consistently is just too risky for them. But it’s also not wise to have all your cash sitting in a bank account where it loses its purchasing power over time. If you are still working on developing your investing strategy but have a lot of cash on the sidelines, consider opening a CD. That way, you take no risk while getting a return on your lump sum of cash.
A certificate of deposit is an account you can open at a bank or credit union to lock away your cash for a certain amount of time. In exchange for stashing your cash in a CD, you’ll earn interest payments. These accounts have pros (your money’s security, for instance) and cons (low returns vs. the stock market). But what’s most important is deciding if there’s an offering — whether short- or long-term, or perhaps with no penalties — that makes sense for you and your savings goals.
Another way to reach your financial aspirations: with a bank that’s totally committed to helping you grow your money, like SoFi. Checking and Savings users who sign up with direct deposit can earn a competitive APY. Plus, you won’t pay any account fees. High interest and none of the usual charges mean that your money can increase that much faster.
Are CDs safe if the market crashes?
Putting your money in a CD doesn’t involve putting your money in the stock market. Instead, it’s in a financial institution, like a bank or credit union. So, in the event of a market crash, your CD account will not be impacted or lose value.
Is a CD guaranteed to make money?
In return for allowing the bank or credit union to hold your money for a fixed period of time, the bank pays you interest. These payments are guaranteed.
What determines CD rates?
CD rates are determined by a combination of a few factors, such as the CD’s maturity (or term) and what the current interest rate environment is (banks will likely use an index rate, typically that of the federal funds rate). Search online to review the best options.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2022 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
SoFi members with direct deposit can earn up to 3.25% annual percentage yield (APY) interest on Savings account balances (including Vaults) and up to 2.50% APY on Checking account balances. There is no minimum direct deposit amount required to qualify for these rates. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. These rates are current as of 11/3/2022. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet
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