Looking to take your savings to the next level? Certificates of deposit (CDs) are a popular savings and investment option that can work for virtually anyone. Let’s dive into all the details about CDs from what they are and how they work to the different types and benefits and drawbacks related to investing in certificates of deposit.
What Are Certificates of Deposit (CDs)?
Before trying to make a decision about a certificate of deposit as an investment option, it’s important to understand the details of this type of financial investment. In simple terms, a CD is a type of savings account that is open for a specified period of time, ranging from a few months to several years. The money you put in a CD earns a fixed (and guaranteed) amount of interest over the designated time.
How CDs Differ from Savings Accounts
At its core, a CD is a savings account, but it differs quite substantially from a typical or standard savings account in a few key ways. First, money that you put in a CD is deposited once upon opening the account and must remain in the account for the entire period, which could be six months, for example. You cannot make additional deposits or withdraw the money early without paying a penalty.
Second, the interest rate for CDs is generally higher than rates for savings accounts and are decided upon ahead of time. Interest rates on savings accounts are not only lower but could also fluctuate to reflect the current financial situation and market conditions. Consequently, rates could vary widely over months and years.
Types of Certificates of Deposit
If you are interested in investing in CDs, then it’s important to understand your options. Although each financial institution will have its own deals and offers, there are five popular types of CDs you should look out for when talking to your bank or credit union.
Traditional CDs
The traditional certificate of deposit operates exactly as previously described. Customers make a single deposit upon opening the account, and they earn a fixed, higher-than-average, interest rate throughout the life of the CD, which could be as short as three months or as long as 10 years.
Jumbo CDs
As the name seems to imply, “jumbo” CDs are certificates of deposit that require a large deposit to open. Although customers can purchase an initial traditional CD with as little as $500, jumbo CDs usually require a minimum investment of $100,000. These CDs may or may not earn a higher interest rate than a traditional CD at the same institution.
Bump-Up CDs
Although traditional CDs set the interest rate at the opening of the account, bump-up CDs allow investors to take advantage of the situation if a bank raises CD interest rates after they invest in a CD. Bump-up CDs got their unusual name because they usually give customers the option to “bump up” their interest rates to a higher number once during the life of the investment.
No-Penalty CDs
Also known as liquid CDs, these accounts allow customers a bit more flexibility and access to their money. With a no-penalty CD, customers can withdraw their funds without incurring any penalties, adding convenience to this form of investment. The downside, however, is that liquid CDs usually carry a lower interest rate compared to traditional CDs in order to cover the cost for this convenience.
Callable CDs
Callable CDs are another option to earn a higher return from your CD investment, but these CDs also come with a risk. A callable CD usually starts with a higher interest rate as compared to a traditional CD. However, the bank that issued the CD has the right to “call back” your investment if interest rates start to fall. In other words, if you invest in a three-year CD at a 5% interest rate, the bank can “call back” your CD if rates drop to 4% at the bank within a year of the investment. The bank must still pay your principal and interest earned up to that point, but you would lose out on earning the higher 5% interest rate for the remaining two years of the initial CD term.
Benefits of Certificates of Deposit
Investors of all income levels often turn to CDs as a safe and reliable way to save money and earn interest on that money. Indeed, CDs have many specific benefits that are worth noting if you are considering investing in one.
Higher Interest Rates
If your main goal is saving, then CDs are a really excellent choice as compared to a traditional savings account for one main reason: a higher interest rate. Even compared to high-yield savings accounts, CDs typically earn more. In fact, on average, CDs earn more than 5% APY in interest, while some of the highest average savings accounts earn less than 1% APY. Even high-yield savings accounts only offer about 4.5% APY.4
Safety and Security
Another huge benefit of CDs is their security as an investment option. CDs are insured accounts that are guaranteed by the FDIC or NCUA, as long as your bank is an FDIC/NCUA-insured institution. The insurance coverage means that even if the bank loses all its money, your money will be safe, up to $250,000.
Predictable Returns
One of the hallmarks of CDs is their guaranteed and constant rate of interest. When you open a CD account, your paperwork will describe the exact interest rate you will earn, and that is exactly what you will receive. Savings accounts, on the other hand, often pay interest that is determined by market conditions, which can be much more variable, with interest rates sometimes changing several times throughout the year.
Low Risk
Finally, the guarantee and predictability of CDs makes them very low risk investments. As long as you have money to save and you know you won’t need to draw on it for a specific period, then you can safely earn a tidy rate of interest on that money and build your savings with little worry.
How CD Interest Rates Are Determined
Even though their interest rates are higher than the average savings account, CD interest rates are still determined by the Federal Reserve’s decisions, specifically the federal funds rate. As the Fed raises and lowers rates, the interest rate a bank offers to its customers investing in CDs will also increase or decrease, accordingly. However, the security offered by CD rates means that you can lock in a particular interest rate, regardless of what the Fed decides in the future.
Comparing CD Rates
Although the Fed and the federal funds rate affect the interest rates that banks will offer for CDs, certain internal factors may influence the exact amount of interest that customers can expect to earn. For example, credit unions, which are nonprofit and member-owned institutions, often offer higher interest rates than commercial banks that are also responsible for paying their shareholders. Different types of CDs may also come with higher or lower interest rates.
Choose HRCCU to Get Your Certificate of Deposit
Members of Hudson River Community Credit Union (HRCCU) are ideally positioned to take advantage of the rates that credit unions can offer. Here at HRCCU, our various types of CDs are very accessible, requiring a minimum investment of only $500. Contact us today to learn more about how you can benefit from HRCCU’s CD options.
