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.
