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As your savings grow and your all-important emergency
fund nears that three to six months of living expenses you might need
in a crisis, you'll find you can afford to let the bank lock up some
of your savings for a period of time. In return you can expect the
bank to give you more interest than they pay on your savings or money
market account, which is liquid.
At a glance
A certificate of deposit (CD) is an excellent way to save
money and earn a higher interest rate than you would with most money
market investments. The drawback is that CDs are not liquid; you're
tying up your funds for a period of time, and if you cash out early
you'll lose interest and possibly principal.
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CDs are time-based, fixed-income investments that
are most often issued by banks but can be purchased through banks
or brokerages. Some banks might require you to come into the bank
to open a CD account, others may let you open one online.
Typically, you invest a fixed amount of money for
a predetermined amount of time called the term, and you're guaranteed
your principal plus a fixed amount of interest, which you receive
periodically throughout the term.
When the term expires you can cash out the principal
and interest, or roll over the CD for another term. You can opt
to withdraw the interest payments as they are received.
CDs can be purchased for terms of almost any duration
although the most popular are between three months and five years.
Almost always, the longer you allow the bank to use your money,
the higher your interest rate. Generally, it's not a good idea to
buy a CD with a term of more than five years. The interest rate
situation could change dramatically during that time and you could
get stuck with a long-term, low-rate CD.
CDs are deposit accounts and are insured
by the FDIC up to $100,000 ($250,000 on retirement
accounts).
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Certificate of deposit |
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Chapter 2: Certificates of deposit
