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How to Invest in a Certificate of Deposit with the Best CD Rates

A certificate of deposit is a time deposit, that many consider virtually risk-free.  While there are many times that you might be willing to invest your capital in riskier assets such as stocks, a certificate of deposit provides a risk-free investment that is guaranteed by regulators. Certificate of deposits are issued by banks, and credit unions, and are similar to a savings account or money market accounts. The difference is that you are agreeing to lock up your money, for a specific period, to receive a larger return on your investment. There are many strategies that you can use to enhance the returns you receive from a certificate of deposit, as well as different styles of CDs that can generate enhanced returns.

The Basics of CD

A certificate of deposit is a time deposit, where you agree to lock up your money for a specific period. In return, you will receive an interest rate that is higher than the rate you would receive if you had your money in a savings or money market account, where your money is not locked up. The reason that you receive a higher return is that the bank or credit union that issues the CD can then use your money for other investments, without worrying that you will want to withdraw it from your account.

The Term – CD Rates

When you open a certificate of deposit you will need to choose the term. CD’s terms can range from 6-months to 5-years. Generally, the longer the term, the higher the interest rate that you will receive for locking up your money.

CD early withdrawal penalties

If you decide to open a certificate of deposit and then have an emergency and need to withdraw your funds, the bank will return your money but will charge you an early withdrawal fee. In some rare cases, a bank or credit union might deny this request for early withdrawal. The penalty will significantly eat into the interest you have earned, making it even less attractive in some instances they placing your funds in a money market or savings account.

CD Ladder – Rolling Your CD

The term of your CD will define how long you will own this investment and near the end of the term, the issuer will alert you that the CD is maturing. At this point, you have a number of options.

  • Role your CD – You can lock up your money for the same term, but the interest rate might be different. This will depend on the current market rate for CD’s of the term you initially purchased.
  • Purchase a Different Term CD – You can find a new CD, with a different tenor and purchase that product.
  • Purchase a Different Asset – You can allow your CD to mature and have your fund returned to the source (such as a checking or money market account) and then invest in a different product.
  • Some banks or credit issuers have automatic rollover – This means they will automatically roll your funds into the same term CD when it matures. If you do not want this feature make sure it is not an option on your CD.

How to Purchase a CD

Certificates of deposits can be purchased online, on the phone or at the bank or credit union location. You will have to own an account at a bank or credit union to purchase a CD, or will need to open one if you want to take advantage of an attractive CD rate. Most CDs can be linked to your checking, savings or money market account, which will allow you to view your statement online. Prior to purchasing your CD, make sure you are aware of any penalties for early withdrawal, or benefits that you might enjoy.

What is the Best CD Term?

There are pros and cons to buying long term or short term CDs. Long-term CDs generally have higher interest rates, providing you with a better return than a short-term CD. Short-term CDs, provide a lower rate but provide you the flexibility if you only want to invest for a short period of time. If you invest in a 5-year CD and pull your money after 6-months you will likely receive much less than you would have if you just invested in a 6-month CD.

Some CDs have no early withdrawal penalties and are called liquid CDs. These are great investment vehicles but comes at a cost as the initial interest rate that the issuer pays is lower than a standard CD. Some CDs also allow you to bump up your interest rate to a different term CD or when the rate climbs on the term of the CD you purchased, but this also comes with a cost, which is a lower initial rate. These bump up CD are popular as they provide investors with the flexibility when they uncertain about the future level of interest rates.

When CD Interest Rates are high

One of the issues you might face is the timing of when to lock in a short term or long term CD. When interest rates are elevated, locking in a long-term CD can be beneficial. You can lock in a long-term return that is nearly guaranteed and will not have to roll you funds for possibly 60-months. If you lock in a 6-month CD, and rates move lower, you will forego the benefits of locking in higher rates.

When CD interest Rates are low

When rates are low, locking in a long-term rate might provide you with a return, but you will be locking those rate in when interest rates are low. If interest rates increase over the next year or two, you will be stuck with a low rate. By purchasing a short-term CD when rates are low, you will be able to roll into a new CD, when rates start to climb.

How do you know when Interest Rates are Low or High

While determining the level of interest rate is not an exact science, you can read forecasts issued by your bank, which can guide you in determining which CD term is the best one for you. Additionally, each country’s central bank has an interest rate forecast. If you read the Federal Reserve’s forecast, you will have a better idea of where they believe rates a going.

What is a Jumbo CD?

A jumbo certificate of deposit is a CD that has increments in large denominations typically $100,000. Since the amounts are large, the interest rate that you will receive will generally be higher than standard CDs. Additionally, some banks will allow you to negotiate your interest rate, especially if you are willing to forego access to your funds for a significant period of time.

CD ladder – Creating a Strategy

If you plan on allocating a portion of your savings to CDs, you can consider a strategy that will allow you to take advantage of a long-term CD, but still, provide you enough flexibility by using short-term CDs. To do this you can formulate a laddering strategy.  Here you would purchase different terms of CDs, in an effort to generate the best average CD rate.

Create a CD’s Barbell Strategy

A Barbell allows you to generate returns by customizing the mid-section of the CD market. For example, if you plan on purchase $10,000 worth of CDs, you could consider purchasing $2,000 or 6-month CDs, $2,000 or 12-month CDs, $4,000 or 18-month CDs and $2,000 of 60-month CDs. Your laddering strategy would then provide you with an average rate. In this example, the average term is approximately 29 months, which provides you with a better rate than the 6 and 12 months CD, but gives you the flexibility to roll your CDs when they come due in 6 and 12 months.

Structure CDs

Some banks will help you customize your CDs and peg the returns to another product other than interest rates. For example, you could create a CD that is tied to the performance of the Dow Jones Industrial Average. If the price of the average increases, you would receive a certain percentage of that return. These products are principal protected, meaning you will not lose money if the index moves lower, you just will not receive the standard interest you expect. So, your returns will either be a percentage of the return of the index or zero. These products are generally geared to investments that are in large increments.

CD Security

CDs are very safe investments because they are insured by the Federal Deposit Insurance Company (FDIC). This makes a CD as safe as a saving or checking account. Credit Unions are covered under the NCUA insurance. You basically have a government guarantee that if your bank defaults, they will cover your CD. The FDIC insurance has limits, per each account, which is usually $250,000. This means that if your issuer defaults on its payments that maximum the FDIC will insure per account is $250,000. If you plan on placing more than this amount in a CD, make sure you set up multiple accounts to ensure the proper coverage.

Credit unions are not FDIC insured, however they are insured by the National Credit Union Administration (NCUA), which is backed by the U.S. government and considered just as good as the FDIC. The NCUA insurance works, just like FDIC insurance, and the coverage limits are equivalent.

CD’s – Risk versus Reward

It’s important to understand that the reward that you receive is commensurate with the risks that you take. Since a CD is a very low-risk venture, the returns that you receive will be much lower than the returns that you should expect with riskier assets such as stocks.

If you plan on investing in a CD, you definitely want to find the highest rate.  Each bank or credit union will offer slightly different rates or might offer incentives for new customers. To find the best yield, you can use FX Empire best bank rates comparison tool.

Alternatives to Bank CDs

An alternative to bank CDs is Brokered CDs. These are certificates of deposits that are offered by some stockbrokers and in many circumstances offer higher interest rates than a bank or credit union CDs. Stockbrokers often offer a wide range of investment options including money market accounts as well as CDS and instead of opening an account at a bank you can open a brokerage account and purchase a CD from a stockbroker. Additionally, brokers often offer bank CDs from different banks. So instead of opening multiple bank accounts, you can purchase CDs from different institutions in your brokerage account.
While this gives you the flexibility to choose from multiple sources brokered CDs come with additional risks. Some of these CD might not be FDIC insured. So, while they might pay a higher interest rate if the issuer defaults you will not be covered by the government.

How to find the best CD rates

Certificates of Deposits are time deposits were you agree to lock up your money for a specific period and receive a return that is generally larger than a typical savings or money market accounts. CDs are offered by banks and credit unions and are insured up to a specific level by the FDIC or the NCUA. There are several different terms on a CD, which include 6-months, 12-months, 18-months, and 60-months.

Many banks offer jumbo CDs which are typically in increments of $100,000 and offer more attractive interest rates. To find the most attractive CD with the best CD rates, you can use FX Empire best bank rates comparison tool to find the best CDs investment for you. There are a number of strategies you can use to benefit from the current interest rate environment including laddering as well as a barbell strategy. Be careful to read the fine print. Most CDs have penalties if you withdraw your money early. There are CDs that allow you to exercise early withdrawal, but these CDs usually have lower interest rates than standard CDs.