Maybe you have a short-term goal like buying a new car, taking a bucket list vacation in two years, or anticipate doing major home improvement. Then too, you could just want a place to stash a portion of your cash outside of the volatile stock market. For sure, there are plenty of good reasons to give certificates of deposits (CDs) a look-see.
What’s to love? They offer a fixed return for a specific period and are FDIC-insured, meaning they carry the guarantee of the federal government for up to $250,000.
“CDs are a popular option with people who want a safe return on their savings. For example, if you're saving for a down payment on a home in a couple of years, it could be smart to park your money in a CD. That way you can be sure you will have enough money when the time comes,” said Andrew Latham, a certified personal finance counselor and managing editor of SuperMoney.com.
Another advantage is that you can likely build savings at a higher rate than simply keeping money in a basic savings account, points out Baruch Silvermann, CEO and founder of The Smart Investor, a free online academy for investors, infoforinvestors.com.
How to play the CD game
There are a few strategies when it comes to CDs. William Spencer, a senior vice present and senior relationship manager at People's United Advisors in Melville explained that with "laddering," you buy several CDs at once that mature at various times. “As they roll off, those proceeds can be utilized if needed or reinvested to the next year, the logic being that each successive maturity will encompass whatever changes in rates have occurred during the prior year.”
With a “bullet” maturity, all CDs mature at the same time. “This is ideal if there is one significant cash flow need. This is also useful if the investor believes that very short and longer-term interest rates are going to be more volatile, but the intermediate maturity area is going to be more stable,” Spencer said.
Use the “barbell” strategy if you want exposure to short-term and longer-term rates while avoiding intermediate rates. “Maybe there’s an expectation that Federal Reserve policy will positively impact short-term rates while longer term rates may be less volatile than intermediate rates,” Spencer said.
What you need to know
Unlike a savings account or money market, where federal law allows you to make up to six withdrawals per month without any penalty, CDs are meant to hold your money for the entire term. “If you require that money in a pinch, you may face a penalty for taking the money from your CD prior to maturity date, so consider your liquidity needs,” said Larry Seigelstein, advocacy adviser at EisnerAmper Wealth Management & Corporate Benefits in Manhattan.
Do however consider inflation. “If inflation rises rapidly or it outpaces the rate at which your interest rates increase, CDs may not be able to keep up because the interest you are earning in the CD may not be enough to counter the inflation,” he explained.
What are some mistakes to avoid? Not shopping around for the best rates could come back to bite you. Some of the best rates are likely to be at online banks, said Seigelstein, who also encourages looking at community banks and credit unions. “Proper due-diligence will be rewarded,” he added. You can use resources like Bankrate.com and Nerdwallet.com for intel on CD rates.
Keep in mind the $250,000 FDIC deposit limit. “Remember that deposit insurance applies by title and ownership at each institution, not [per] deposit, so if you have two separate $250,000 CDs with a single institution with the same title or ownership structure, only half of your total deposits would end up being insured,” Spencer said.
You also don’t want to automatically roll over your CD when it expires; much depends on your goals and cash flow needs. It may be time to switch to another investment that could yield a higher return, albeit with additional risk. Talk to your financial adviser.
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