saving-budgeting
April 22, 2024
Certificates of deposit (CDs) have been a popular savings option ever since the 1933 launch of the Federal Deposit Insurance Corporation (FDIC)[1].A very accessible way to save, the CD is offered by most Indiana banks and credit unions in various amounts with different term lengths.
Is a CD right for you? Learn how it’s different from otherdeposit vehicles and what to expect when you establish one.
How Much Can You Earn With CDs
A CD’s annual percentage yield (APY),or the amount of annual interest it pays its owner, varies on several factors. The CD’s length, the market conditions at the time it was purchased, and the financial institution's policies all play a role in how much the CD will pay out over time. Additional details, such as the compounding frequency, make some CDs more profitable than others.
Generally speaking, the longer the CD you purchase, the more you could potentially earn over its lifetime.
An example would be a $1,000 deposit in a 6-month CD with a rate of 5.00% APY. During that time, the CD would earn around $25 in interest.
Compare it to a 5-year CD at 4.75% APY — this would earn around $261 in interest during its term.
Online calculators give you a good idea of interest you can earn with a CD. These calculators can be adjusted for different rates and CD term lengths. Just remember that market rates fluctuate frequently; the APY of one CD today can be different tomorrow.
Are CDs Good for Building Wealth?
CDs can be suitable for building wealth, depending on the situation — they’re not ideal for everything. CDs offer a low-risk way to safely store money and earn modest interest. They build more wealth than putting cash in a piggy bank or losing it to a risky investment.
Because they are considered low-return deposit products, they may earn less interest than more high-risk options. They may not quickly create wealth for certain goals, like earning enough for retirement. What’s good for some will not be good enough for others.
A financial advisor can help define what’s considered “good” in your situation, but you can also weigh the pros and cons of CDs to help you decide.
Pros of CDs for Building Wealth
- The advantages of a CD compared to options include the following:
- They are low risk, won’t lose value in the stock market, and carry the protection of FDIC insurance.
- They have higher APYs than many savings accounts and high-interest checking accounts.
- They make it easy to plan, as they offer straightforward rates of return.
- Some CDs have low opening thresholds, so even those with modest means can get started.
Cons of CDs for Building Wealth
Some disadvantages of CDs include the following:
- CD rates may not be high enough to compensate for high inflation or some more aggressive savings strategies, such as those needed for an on-time retirement.
- Money isn’t accessible until the set term for the CD expires (maturity is reached.) Cashing it out early loses unearned interest and comes with a penalty fee.
When Is the Best Time to Open a CD?
CD rates are based on current economic conditions, including the prime rate set by the Federal Reserve. Banks have themost attractive CD offers when interest rates are high. As Federal Reserve rates drop, CD rates drop, too. During these times, finding CDs with attractive interest rates may be more difficult.
In a perfect world, you could open CDs when rates are highest and get the most return on your money. However, it’s impossible to know what rates will do in the future. Many consumers use a method called laddering to make the most of CDs' low risk and security while getting the highest rates possible over time.
How Does CD Laddering Work?
CD laddering is a method of opening CDs at different term lengths and times to take advantage of the best interest rates possible.
For example, a consumer would open three CDs with different term lengths: one for six months, another for a year, and another for two years. Each would also have different interest rates.
As the first expires, the consumer gets their money back (plus interest). They can decide to open another CD if the rates are high at that time or use the money in other ways. As each CD matures, the consumer can open new, larger CDs with the principal and interest earned from the previous one.
By opening a mix of long- and short-term CDs, consumers can gain liquidity and earnings and make the most of the market. Longer-term CDs protect against rates dropping over time, while shorter-term CDs allow consumers to open new CDs if rates rise.
Who Are CDs a Good Choice For?
Because CDs lock your money away until they mature, they are a better choice for those who don’t need their funds to be very liquid. While you can close out a CD early, it comes with fees that could cancel out the interest earned and even reduce the principal amount of the CD.
Generally, CDs appeal to those who like their low-risk predictability and the variety of term lengths and rates you can purchase. Since they have FDIC backing, they are also ideal for risk-averse consumers nearing the end of retirement. CDs offer assurance of returns that aren't found in other options — like risky stock market investing.
Alternatives to CDs for Building Wealth
CDs are just one way to earn interest and save money for the future. Other popular options include:
- Savings accounts, which offer a competitive APY during periods of high interest rates and access to funds at any time.
- Individual Retirement Accounts (IRAs), which offer tax advantages and opportunities to build wealth for retirement.
- Money market accounts, which may offer higher APY rates than a traditional savings account and provide easy access to cash with checks and ATM withdrawals
- Interest checking accounts, which don’t pay as much as savings accounts but still provide a blend of flexible checking tools with a noteworthy APY.
How To Open CDs
CDs have a specific set of features that make them attractive to many consumers. If you are interested in a low-risk option, it is worth discussing CDs with your financial professional. Visit Centier’s CDs page to get started.
Source:
[1] FDIC.gov, U.S. Banking and Deposit Insurance History, Accessed March 6, 2024 https://www.fdic.gov/about/history/deposit-insurance/1930-1939.html
