12/30/2022
In today's financial universe there are many products to diversify your capital, save and obtain dividends. Thus we find Certificates of Deposit (CDs), which we will discuss in more detail.
What is a certificate of deposit?
In principle, we can establish that a certificate of deposit or CD represents a special kind of savings account. Its particularity is that it offers you higher interest rates than the conventional ones because you must leave the money for a certain amount of time.
That is, you cannot take it out before the maturity date without incurring a penalty.
These banking products are usually available at banks, credit unions and online institutions. They have an expiration or maturity date, a fixed term and an interest rate that does not vary.
Like savings accounts, they are FDIC-insured and usually have an average duration ranging from 1 month to 5 years or even more.
How a fixed-term deposit work?
The process for signing up for a certificate of deposit is not very different from other bank accounts. It is something you can do in person or, depending on the institution, through an online form.
The biggest difference with respect to other products is that your initial deposit will be the only one because you will not be able to make contributions afterwards.
One of the advantages of CDs is that interest is compounded and added to your balance daily or monthly. Once the term is up, the bank can automatically renew it or you can withdraw the money.
There are also CDs with intermediate expiration dates. When it reaches each one, you have 1-2 weeks to make penalty-free withdrawals before the next maturity.
Types of CDs
Depending on your financial needs, banks have several types of certificates of deposit; namely:
- Traditional. This is the most common because it has a fixed rate and a set term.
- Jumbo. For this product with a higher interest rate than a savings account, there is usually a minimum deposit of $100,000.
- IRA. This is a CD that you buy with your retirement account, which can also be used to invest in stocks, bonds and other assets.
- No penalty. Although this instrument does not charge you for early withdrawal, it is characterized by having a lower interest rate than the others.
- High yield. As its name indicates, it is a certificate of deposit with a higher than average yield.
Advantages of certificates of deposit
The choice of a CD may be subject to different factors and financial goals. Since it is a low-risk investment, it serves to diversify your funds, especially when you have extra money or want to avoid its devaluation due to inflation.
Among its most notable pros, we have to mention:
Security
As with other banking products, CDs are federally insured in case the institution in question closes. Currently the limit is $250,000 per person per account. With state and federal credit unions, the NCUA takes care of insuring the money.
Higher rates
Generally, certificates of deposit offer a higher interest rate than a money market or savings account. This is because you commit to leaving the money in place for a certain amount of time.
Although this varies from bank to bank, the recommendation is to compare the APY interest rate of the CD with high-yield accounts before making a decision.
Guaranteed Returns
CDs are predictable banking products that let you know how much you can accumulate before they mature. For this, there are several calculators that make it easy for you to choose or the ideal amount you could put away. This is especially useful when you have a long-term goal.
Applying the CD ladder
This staggered method allows you to have liquidity and take advantage of different interest rates. It consists of contracting several certificates with different maturity dates in order to have money at precise moments.
No maintenance fees
Often, bank fees are the ones that prevent your money from growing as you want it to. This does not happen with a CD, which has no maintenance fees, letting you keep everything you accumulate until maturity.
Disadvantages of a time deposit
Among the disadvantages of a CD, the following are worth noting:
- Lower drawdown. Unlike MMA and savings accounts, CDs do not let you withdraw money, write checks or use a debit card.
- Low returns compared to other investment products. The safer the investment, the lower the dividends you get. Although these financial instruments give you certain returns, they do not reach the level of stocks, bonds and other riskier assets.
- Inflation risk. There will be instances when the rising prices of goods and services are above the APY of the CD. This is something you should evaluate when opting for this investment.
Español: ¿Qué es un certificado de depósito a plazo fijo?