Certificates of deposit have been a popular component of Americans' portfolios for generations. At any given time, there can be upward of $1 trillion from U.S. investors sitting in CDs gathering interest. But when it comes to your overall portfolio, where do CDs fit?
Most financial advisers agree investors should keep part of their assets in cash and cash equivalents in case of a sharp economic downturn. While rates can sometimes dip so low as to render CDs almost useless, in a normal-rate environment, keeping a portion of those cash reserves in CDs can allow you to lock in a higher rate of interest than you'd get in conventional savings accounts, says Herb Montgomery, Certified Financial Planner and president of the Montgomery Financial Group in Orleans, Mass.
"You're getting a higher rate of return," Montgomery says. "You're giving up access to the money, so they have to pay you for it."
Montgomery says creating a CD ladder that starts at six-month CDs and extends at six-month intervals out to 24 months can give investors quicker access to their funds and optimize returns.
"After 18 months, I've got six-month CDs at a 24-month (interest) rate, so in a way you sort of beat the system," Montgomery says. CDs are also insured by the Federal Deposit Insurance Corp. up to $250,000. "They're a safe investment even in the most severe recessions," Montgomery says.
CDs are especially useful if you're allocating part of your portfolio to pay for a predictable expense sometime in the future. You can time the CD's maturity to coincide with when you'll need the money, says Derek Kennedy, president of Kennedy Wealth Management in Knoxville, Tenn.
"If you know you're going to have to make an education payment in two years with a CD, you know that value is going to be there in two years," Kennedy says.
Montgomery cautions that keeping too much of your portfolio in CDs can hamper your ability to keep up with inflation. That's especially true when rates are extremely low.
"CDs aren't designed to combat inflation or give you any type of rate of return on investment," says Montgomery. "It's a place to park some cash and get a little bit of return on it."
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