3 Perks of Investing in CDs
KEY POINTS
- CD penalties can provide incentive to leave your money alone for the duration of the CD term.
- Ladder your CDs and you can generate predictable income over time.
- The best banks are FDIC insured, so your cash in CDs is protected.
Thanks to the higher interest rates we've all been living with, APYs (annual percentage yields) on certificates of deposit are up across the board. As such, it's a really good time to open one -- you might say that CDs are having a moment.
If you're not familiar, a CD is a type of deposit savings account that pays a fixed interest rate on your money for the duration of a set term. If you open a 1-year CD that pays an APY of 4% and you deposit $1,000, you'll finish out that year $40 richer. The only catch is that you can't access your money without penalty for the duration of the CD's term -- but this can be helpful if you're worried about being tempted to spend the money (more on this below).
Let's take a closer look at a few of the benefits that come from investing in CDs.
1. CDs can help you keep your mitts off your money
While a savings account is also a great place to keep your spare cash, one of the benefits it'll come with is the ability to access your money fairly easily. Even if you can't directly withdraw cash from your savings account via ATM and must transfer it to a checking account first, that's still an easy step to get at the money. This can be a problem if that money is for a goal like paying for a wedding or buying a home in a few years.
CDs, on the other hand, have a built-in hands-off helper -- if you withdraw your money before the CD term is up, you'll have to pay a penalty that's usually equal to several months of interest earned. And if you withdraw cash earlier in the term, you could even find yourself facing a penalty that eats into your principal -- meaning you'd lose some of the money you started with.
For this reason, you don't want to keep your emergency fund or any other cash without a defined timeline in a CD -- opt for a savings account or perhaps a money market account instead. But if you're confident that you can lock your money up for a period and not need access to it, opening a CD can be a great way to stave off the temptation to use the cash.
2. CDs can help you generate guaranteed income
If you've got a pile of cash and want to generate predictable interest income from it, CDs have your back. Specifically, you'll want to consider building a CD ladder. Let's say you have $10,000 you want to put into CDs. To create your ladder, you could:
- Put $2,000 into a 6-month CD
- Put $2,000 into a 1-year CD
- Put $2,000 into an 18-month CD
- Put $2,000 into a 2-year CD
- And put $2,000 into a 3-year CD
Every time a CD term finishes, you can take the money you've earned and reinvest it in a new CD (or spend it!). And you can use the interest income you earn along the way.
3. CDs are a safe place to keep your cash
If you put some of your hard-earned cash into a CD, you won't have to worry that you might lose that money, assuming you check for one crucial bank feature first. The Federal Deposit Insurance Corporation (or FDIC) is an independent agency of the federal government, and it was created in the wake of bank failures during the Great Depression.
If your bank is covered by FDIC insurance, it means that up to $250,000 of your cash in qualifying accounts (including checking, savings, money market, and CDs) is protected against loss in the event of bank failure ($500,000 if it's a joint account). If your bank goes under at any point during your CD term, the money in your account will be returned to you. Just make sure your bank is insured -- it likely has the FDIC logo on its website, or you can look it up using the FDIC's BankFind Suite tool to be sure.
All things considered, CDs can be a great way to keep some of your savings safe while generating predictable interest income. If this sounds good to you, take advantage of higher CD rates while we still have them.
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