Safety is the name of the game when it comes to your savings. The last thing you want when trying to build a savings cushion is to lose it all and return to square one.
Fortunately, you can stash savings in a number of safe financial instruments that also reward your efforts with a little free money in the form of interest.
While they aren’t going to set the world on fire with sky-high returns, the following investments each provide a safe place to park your savings:
Certificates of deposit
- What they are: Certificates of deposit, or CDs, are federally insured time deposits with specific maturity dates that may range from several weeks to several years. The financial institution pays you interest at regular intervals. Once the CD matures, you get your original principal back plus any accrued interest. There are several different types of CDs, including jumbo, callable and flexible.
- Risk: CDs are considered safe investments. Most are insured by either the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions), meaning they can’t lose principal on account balances of $250,000 or less through Dec. 31, 2013. On Jan. 1, 2014, the standard insurance amount is scheduled to return to $100,000.
- Liquidity: CDs aren’t as liquid as savings accounts or money market accounts because you tie up your money until the CD reaches maturity — often for months or years. It’s possible to get at your money sooner, but generally you’ll pay a penalty.
Pros and cons: CDs provide interest income with relatively low risk. However, if you try to cash out your CD prior to maturity, you may incur a penalty, such as the loss of interest for a quarter. Federal law requires a minimum penalty of at least seven days’ simple interest on amounts withdrawn within the first six days after deposit. The law doesn’t set a maximum penalty, so banks can charge as much as they want. Another downside: Earned interest is subject to income tax.
CDs also carry reinvestment risk — the risk that when interest rates fall, investors will earn less when they reinvest principal and interest in new CDs with lower rates. Another risk occurs when interest rates rise. For example, people who lock into an interest rate over several years may regret their decision if rates on newly issued CDs suddenly rise.
Consider laddering CDs — investing money in CDs of varying lengths and terms — so that all your money isn’t tied up in one instrument for a long time. Learn more about CD laddering in Bankrate’s Investing Basics.
CD returns often are higher than those of traditional savings accounts. Still, inflation and taxes easily can significantly erode the purchasing power of money invested in CDs.
- Where to find them: You can purchase CDs at banks, credit unions and brokerage firms. Bankrate can help you find the best CD rates currently available.