What is a CD, or a Certificate of Deposit?
You've probably heard of Certificates of Deposit at your local bank, but just what is a CD? Like a savings account, CDs act as a place to store your money while earning interest. But unlike savings accounts, CDs typically have a higher interest rate. So what's the catch? You must leave your money in the CD for a set period of time. In this guide, we'll go over the benefits and drawbacks of Certificates of Deposit, so you can plan your finances wisely!
CDs vs. Savings
While most people have a simple savings account, not everyone has a Certificate of Deposit. Both are fairly simple to open, so what are the main differences between the two?
- A CD typically has a term length of a few months to a few years. After the CD matures, you can cash out. A savings account can be stored indefinitely.
- You can withdraw your money from your savings account whenever you'd like, but your money stays in the CD until the term length has been reached.
- While both savings account and CDs will accrue interest over time, a CD is usually a higher-interest option.
Why Choose a Savings Account?
If you prefer to have very fluid funds, then the savings account is probably the better option. Withdraw your money from a CD prematurely, and you'll face a penalty. Savings accounts may generate far less interest, but they are much more forgiving. You can easily withdraw the money you need for an unexpected emergency, for example.
Why Choose a CD?
While the terms of a Certificate of Deposit may be stricter, you can shop around to find the term length that you want. Some CDs mature after just a few days, while others take years to do the same. That means you have a little more flexibility than you might initially think. Plus, you can yield quite a bit more money from a smart investment. If you have money sitting in your savings account, you can put it in a CD to grow much more quickly than even a high-yield savings account. What if you need emergency cash? You can either pay the penalty or consider an alternate source, like a cash advance or payday loan.
If you're intimidated by the long-term investment of a CD, consider a strategy known as "laddering.” Some investors divide their savings into several CDs and stagger the maturation. For example, you can invest your $10,000 into a single five-year CD, but that will tie up your funds for half a decade. What if you split that sum into five $2,000 CDs that mature at different times? As each CD matures, you can roll it into a new account. Ideally, you'll have a CD that matures every year. This allows you to take advantage of favorable interest rates, while offering greater flexibility than a single large investment.