Definition:
Certificates of deposit are really no more than loans
you make to a bank.
The loan is usually for a fixed period of time, such as 3-months,
6-months, 1-year or 5-year. In return, the bank gives you a fixed
interest payment.
You promise to leave all the money, including the interest, with the
bank until the time period is up. They are insured by the FDIC up to
$250,000.
You may consider setting up a CD if you know that you
will be using the money in a specific period of time and will not need
to access it immediately.
However, this is generally for very short periods. If
you are looking at more than five years you should consider mutual
funds.
If you are considering a shorter period you should also
consider a money market account.
A CD rate will not go up if the interest rates begin to
rise whereas a money market account will.
If the interest rates are close it may be better to go
with a money market account, because the interest rates vary according
the current market.
The only negative is that you will pay a penalty if you need to take
back your money before the time period is up.
You also run the risk that interest rates will go up on other products
while your money is tied up in the bank.
One of the biggest risks of a CD is that you will not
earn interest at the rate of inflation.
Additionally if you do need to access the money before
the CD term is up you will pay penalties and early withdrawal
fees.
If you are considering opening an IRA that is a CD you
would be better off going with an IRA that is connected to mutual
funds.
CDs have different options when it comes to paying
interest on the account. Many CDs will deposit the interest into one of
your accounts monthly or quarterly.
Other CDs will add the interest back into the CD or pay
the interest at the end of the CD term. Additionally some CDs will
automatically roll over into a new CD at the current market
rate.
If this is the case, you need to mark the date on your
calendar so that you can withdraw it and put it into a better
investment option.
Certificates of deposit are bought by money market
funds, these funds pay slightly less than certificates of
deposit.
The benefit is you can take your money out at any time
without a penalty. The other benefit is that, if interest rates go up,
you aren't locked into a fixed rate of return.
Many people prefer this flexibility. Money market
deposit accounts are also insured by the FDIC.
If you are
considering Retirement Planning, call for a free consultation today.
