Choosing a Certificate of Deposit
Certificates of deposit or CDs are low-risk investments traditionally issued by a bank. Over the years different types of CDs have emerged offering higher interest rates, but also more risk. More options exist for investing in CDs so choosing the right CD for your needs has become more complicated. When researching the various types of CDs, it is important to be aware of certain features that pertain to every type of certificate of deposit.
Every financial institution has it own policies regarding minimum deposits. Some banks allow a low $500, but others require $1,000, $2500 or more. You have to invest only the amount you are comfortable with. Another smart move is to only invest money that you won’t need for living expenses. Certificates of deposit are best as long-term investments.
Every CD is invested for a specific period of time. The time period ranges from three months to 10 years or more. The maturity date is when this fixed period of time ends. It is important to read the disclosure statement of CDs to know the maturity date. Some depositors get a rude surprise when they realize they unknowingly signed up for a five- or ten-year CD.
Very High Interest Rates
Before investing in a CD, know what the interest rates are. Many investors shop around looking for a financial institution that offers the highest interest rates. In most situations, the long-term CD of five years or more provide the best interest rates. However, sometimes you will see rates advertised that are much higher than the average rates. Before purchasing these CDs, do your due diligence. In many cases these higher rates are offered by companies that are not members of the Federal Deposit Insurance Corporation (FDIC). This means that the money you invest is not insured if the bank should fail. Avoid any institution that does not offer insurance for your certificate of deposit. The FDIC insures bank deposits for up to $250,000. BestCashCow.com lists only CDs issues by FDIC insured banks. Most, but not all CDs and time deposits listed by credit unions on BestCashCow.com are insured by the NCUA (those credit unions not insured by the NCUA are so indicated on their overview page on BestCashCow.com).
Fixed or Variable Interest Rates
You also need to know if the CD interest rates are fixed or variable. While traditionally interest rates were fixed, certificates of deposit now provide more flexibility. With fixed interest rates you get the same rate for the duration of the investment. With variable interest rates there are several ways the rate changes. Some CDs follow a predetermined schedule of changes while others follow an index such as the Dow Johns Industrial Average. CDs with variable interest rates have more risk.
Another important piece of information you need to know is when and how the financial institutions pays the interest. Some CDs pay monthly while others pay quarterly, semi-annually or annually. Banks may also send a check or use an electronic transfer. The disclosure statement provides these details.
When choosing a CD, ask if the CD is automatically renewed on the maturity date. You also need to know whether the renewal uses the same interest rate or the current interest rate. Interest rates change frequently so you want the renewal to reflect the best rate available at the financial institution.
Early Withdrawal Penalties
If you need to withdraw the money from the CD before its maturity date, the bank or other issuing financial institution will often charge fees. Find out what the fees are and how much they are before investing. While you may think you won’t need to withdraw money early, it could happen and you should understand what the penalties are.
Certificates of deposit range from the simple to the complex these days. It is important to understand your financial goals to know which type of CD is best for your needs. Reading the disclosure statement carefully and asking question is the best way to choose a CD that reflects your risk tolerance and your long-term goals.