If you want to invest safely, some experts will tell you to invest in a CD, or certificate of deposit. In a nutshell, a CD enables you to put your money into a savings account offered by banks, credit unions and financial brokerages at slightly higher interest rates than a conventional savings account. The catch: Typically, you can only withdraw money from the account occasionally to avoid incurring a penalty.
There’s an appeal with CDs for many investors because unlike some investments, such as stocks, you won’t lose money. But unless interest rates skyrocket, you probably won’t get through your investment period feeling like you won the lottery either.
Then again, it depends how you approach investing in a CD, says Alexander Lowry, a professor of finance at Gordon College and executive director of the school’s Master of Science in Financial Analysis program.
“Using them can be as simple or as complicated as you want,” Lowry says. “If your [investing] needs are basic, it’s easy to put money into a CD and start earning more than you were earning in your savings account. But you can also add more complex strategies if you have particular goals in mind.”
[See: 10 Investing Themes to Remember for 2018.]
If you’re thinking of investing in CDs, here are five things you’ll want to know to ensure opening an account is right for you, and expert-backed tips for choosing a CD that will help you achieve your financial goals.
Keep in mind your investment will be safe. The Federal Deposit Insurance Corporation, or FDIC, insures CDs up to a $250,000 threshold.
Understand the process of investing in a CD. First, you have to pick what kind of CD you want to invest in. There are quite a few of them, says Matthew Murawski, a financial planner with Goodstein Wealth Management LLC in Los Angeles.
There’s a traditional CD, a bump-up CD, a liquid CD, a zero-coupon CD, a callable CD and a brokered CD, says Murawski. They’re all unique. A traditional CD you’d find at a bank with a fixed rate and a fixed time. A bump-up CD, on the other hand, enables you to ask for a higher rate during that fixed period of time (typically just once) if your bank increases its annual percentage yield, or APY. And a liquid CD is a low or no-penalty option, where you can withdraw your money without incurring a fee. Meanwhile, a zero-coupon CD is a CD you buy at a discount, a callable CD sometimes offers a faster payout and a brokered CD is a certificate of deposit you can get from a brokerage that’s still FDIC-insured.
Do you happen to have an extra $100,000? You could put that money into a jumbo CD and get higher-than-usual rates (typically around a percentage higher). For instance, Ally Bank currently offers 1.75 percent for a CD, assuming you deposit $5,000 or less into it. Meanwhile, if you deposit $100,000 into one of Michigan State University Federal Credit Union’s jumbo CDs, you’ll get a 2.66 percent interest rate.
Some banks have minimums as low as zero, such as Ally Bank; others, like TD Bank and U.S. Bank enable you to open an account with a $250 deposit, though $1,000 is typical. And others may require $2,500, or $5,000 or more. When you put your money into a CD, it stays there for a fixed amount of time, typically one, two, three or five years, though you can find CDs that last for six months. If you need your money back before the duration is up, you can get it — but with a penalty. So, if you want to invest your money but think you may need to withdraw it sooner, consider opening an interest-generating savings account instead.
[See: 10 Long-Term Investing Strategies That Work.]
“Right now, as we are in a rising interest rate environment, locking money into given rates at the moment won’t make sense for most people,” Murawski says, emphasizing the drawbacks of investing in CDs.
But if you are interested in investing in CDs, he suggests taking a look at bump-up CDs. With these types of CDs, you can get the rate raised within the fixed amount of time, provided “the initial interest rate, although lower, isn’t insulting,” he says.
After the fixed amount of time, generally you’ll have a grace period that’s typically about 10 days, where you can grab your money without penalty; if you don’t take the cash, often your original deposit and earned interest will rollover into another CD for a fixed period of time — and continue earning interest.
Remember: CDs are predictable. Because most CDs have fixed interest rates for a given number of years, you can estimate how much you’ll earn on your investment. So let’s say you put $5,000 into a CD at a 2.2 percent interest rate for 24 months. In that case, you’d be able to go to an online CD calculator and see that in two years, you’ll have $5,222.42, or an extra $222.42, for doing nothing other than parking your money into the CD.
But that same predictability can be a turnoff for some investors. If you invest $5,000 in the stock market, you may earn considerably more than $222.42. That predictability means that if you’re looking to grow your money with CDs, it may be a slow process.
Think about that fixed rate. Interest rates are poised to continue surging this year and perhaps in the years ahead. That’s why many financial experts are skeptical about investing in a CD that can’t be touched for many years.
“The current rising rate environment makes it beneficial to use shorter-term CDs and then roll them over more frequently,” says Brannon Lambert, a certified financial planner and owner of Canvasback Wealth Management LLC in Raleigh, North Carolina.
If interest rates start dropping again in the future, then fixed rate CDs for long periods of time make a lot of financial sense, he says.
Consider all CD investing strategies. “Most people just choose a CD based on the length of time that they prefer, looking at interest rates and the amount of time they’re able to lock their money up,” Lowry says.
But there are two other popular approaches, he says. “Laddering is a strategy of buying multiple CDs with different maturity dates — from short-term to long-term maturities,” he explains. In other words, instead of investing a huge wad of money in one five-year CD, maybe you put some in a one-year CD, a two-year CD and a three-year CD, so you’re staggering your rollovers. “This helps you keep money available and avoid investing all of your money when interest rates are at their worst,” he says.
Or you could do a bullet strategy, where you would put money into a five-year CD, and approximately three years later, put more money into a two-year CD, Lowry says. That way, both CDs are poised to end right about the same time.
[Read: How to Create a Retirement Investment Strategy.]
“A bullet strategy allows you to have all of your money available when your [financial] goal arrives. You’ll earn more than you would have earned in savings, and you’ll be able to write a large check when the need arises,” Lowry says.
More from U.S. News
Your Month-to-Month Guide to Savings
9 Easy Ways to Save $500 More Per Year for Retirement
9 Investing Myths That People Still Believe
How to Choose a CD originally appeared on usnews.com
