Certificate of deposits, or CDs, are offered by banks as a way to attract additional deposits from customers in exchange for a higher yield. It works out for the banks because CDs have a fixed time period where there are penalties for early withdrawal, giving institutions a high confidence that the deposits can be used for lending. On the other hand, it works for customers as well because of the guaranteed (and often higher) interest rates.
Sounds great. Yet, it’s been a decade since I purchased one. Back then, I bought GICs (it stands for Guaranteed Investment Certificate, the equivalent of CDs in Canada) so technically, I have never purchased a CD before.
“But being FDIC insured, it’s covered up to $250,000.” I know I know, it’s got great rates as well, but I have instead opted for online savings accounts since it offers a similar yield. My reasoning was that since CDs are inflexible because it lock my money up.
I bet that turns some of you away from it too.
Inflexibility of a CD Isn’t Necessarily Bad
Being too flexible isn’t always good. Since I sold half of everything I invested in the stock market several weeks ago, I actually made more trades with my added purchasing power. Sure, the last few weeks were quite profitable but I found myself checking my stock performances and CNBC ALL THE TIME. Instead, I much rather be spending time on what’s more important like:
- Working on My Websites
- Spending Time with Emma
- Enjoying Life
Sometimes, not having access to your money isn’t always a bad thing. You won’t be spending as much, or more importantly, worry as much. Without the ability to overdraw your checking account into savings, you might even save more money. Funny how inflexibility can work in your favor…
Of course, you can always ask me to hold onto all your savings to get the same effect, but if you rather get some interest rates along the way, certificate of deposits might be the ticket.
{ read the comments below or add one }
I use CDs for two distinct purposes.
One is my “OMG, I lost my job or landed in the hospital” emergency fund. This is seperate from my ‘small household/car emergency/vet bill fund (which is actually more of an escrow account, because those expenses will happen, you just don’t know when – that fund is about three months expenses and is at an online savings account). I have 12 laddered CDs comeing mature at approximately one month intervals. They are rolling over and at least keeping up with inflation plus a bit. If I don’t need them, they’ll pad my retirement if I have to retire in a ‘down market’ year.
The other thing I use CDs for is for a large planned future expense. I have a major house upgrade that I’m planning to do in 2012 – that money is parked in a CD waiting for me.
In both cases, the market would be a poor choice as capital preservation is key. I only put money into stocks that I don’t need for at least five years. There’s no one size fits all – you have to choose the investment vehicle that fits your timeframe and risk tolerance.
i hope to have saving money total 100k when reach age 30…do u think it is enough for an adult?
$100k by 30 is definitely a very good start. Just keep at it though because you will need much more during retirement.
nowdays i seldom save money into this type of deposit, i more prefer to use my money to invest in diversified fund, do u think better?
I think of CDs as targeted liquidity. Let’s say you have a large purchase in mind a year from now like a car or a house. You may have invested the money for a couple of years to help build it, but now you are getting close to the goal of the purchase. You don’t want that money at risk and you you still want a return– a one year CD is probably the answer.
Like any other financial instrument– a CD is a tool and every tool has a purpose . . . be sure you use the right tool for the right job.
I’m actually in the extra same boat – need money within a year to possibly buy a house. I opened a 6-month CD for a good chunk of my savings so I get a higher rate of return.
Ohh and I forgot to mention Liquid CD accounts – you can open these ones too. It acts almost like a savings account and you can also withdraw cash out when you need to. Of course you have to leave a certain balance but that’s as good as it gets.
I feel the same way about CDs. I’d rather put my money into an Online Savings Account that has a decent interest rate because I’m able to access the money whenever I need it.
In anycase I’m going to open an online trading account – I’m getting tired of waiting so long to just make a buck.
I love the CD ladder strategy that marci wrote about. Maybe you should write about how that’s done as a follow up to this article.
I think most young people (that’s you included, David) think that CDs are boring but if you think about it, most people who don’t worry too much about money invest in a ton of CDs.
Yep – some of my CD’s are still at 5%, which I am very happy with at the moment.
One of the strategies not mentioned if you think you are going to need the money at some specific point in time is laddered CD’s. Take your money and divide it into chunks that meet the minimum (or better) CD deposit requirements. Then stagger the maturity dates so that they mature in 3 month intervals, or 6 months, or at a date when you think you will need the money. Once you get the initial time frames working ok, then set them up for automatic renewals.
When I knew I would need money for the house remodeling/repairs, I set 3 small CD’s up to renew every 3 months, but I set them up at one month intervals to start with. That way, I had a CD that would mature each month and I could draw it out for my cash house repairs as needed, without a penalty. Worked well.
Now that I am thru with that, I have one smaller CD that matures every 6 months, and other CD’s staggered at year and 2 year intervals. And I have a big CD that doesn’t mature til 2015 – nice interest still – at retirement time. It does take some guessing into the future, but then I am not usually in a hurry to spend money and don’t mind waiting for a CD to mature. In case of emergency, I can always write a check and “borrow” against my CD…but only in an emergency. 🙂
Most CD rates are so low now that it almost doesn’t make sense to have money in a CD because they are not liquid just in case you need the money. You really won’t make much at all, better off keeping the money in a money market account.
It almost boils down to whether you think the rates will actually go up or down right? Just remember that while people were complaining that the rates were low when it was down to 3%, it would sound amazing now (not to mention that you would’ve skipped the whole financial crisis where pretty much any investment was down huge).
Glad to hear that you are warming up to CDs. I’ve been investing in CDs for the past 20 years and to be honest it has beat all my other investments (not sure if it’s a good or bad thing).