The Advantages of Certificate of Deposits (CDs)
By Synchrony Staff
- PUBLISHED August 01
- 3 MINUTE READ
You’ve probably heard the term certificate of deposit or CD before. But do you know why you would want to open one?
This article details some of the characteristics of a certificate of deposit, pros and cons and other factors to consider, so you can make the right decision regarding how CDs can help you meet your financial goals.
What Advantages Does a CD Offer?
When you open a certificate of deposit, you deposit a certain amount of money in an account and agree on an interest rate and term with the bank. Here are some advantages of having a CD:
- Security—Just like other depository accounts, the Federal Deposit Insurance Corporation (FDIC) insures CD deposits. All CD accounts are insured up to $250,000 per depositor for each ownership category.
- Higher Rates than Many Other Deposit Products—CDs typically offer higher interest rates than other FDIC insured products such as savings or money market accounts.
- Predictability—Banks and credit unions typically offer fixed rates for fixed terms, so you know exactly what you will earn over the duration of the CD. Terms typically range from as few as three months up to 60 months.
The Disadvantages of a CD
While a typical certificate of deposit usually yields a higher return than a traditional savings account, the tradeoff is that the money cannot be withdrawn from the CD without penalty before the end of the CD term. An example of a penalty could be that you pay the bank back 90 days of simple interest at the current rate. If your term is longer, the amount you pay could be higher. It’s important to understand the penalties associated with early withdrawal before opening a CD.
An additional and often overlooked drawback of a CD is if too much of your money is tied up in a CD and interest rates on other financial products rise, you may miss out on higher earnings.
In short, you get the most for your money when you stay with the CD until it matures. People who want regular access to their savings while still benefiting from high interest rates may prefer a high yield savings account.
How to Benefit from Your Certificate of Deposit
Certificates of deposits can be used for a variety of purposes, including saving for both short- and long-term goals. Depending on how your savings will be used and the length of the term, choosing a certificate of deposit has advantages and disadvantages.
Some people choose to use a CD to save for buying a home. For example, someone who knows that they plan to buy a house in two years could benefit by taking out a CD for twenty-four months. The money will safely grow in an FDIC insured product until it’s time for the down payment.
The security of CDs makes them an attractive choice for those saving for retirement. However, timing is important as waiting for the CD to mature could push back your retirement. An IRA CD is an option here. This type of CD lives inside traditional or Roth IRAs and can be accessed at age 59 ½. Talk to a financial advisor before opening or contributing to an IRA.
One strategy that helps mitigate the liquidity challenges associated with certificates of deposit is using laddering. Instead of putting all your money into one CD, divide your total investment into several smaller amounts and put them into CDs with staggering maturity dates. This process allows you to regularly access your funds without penalty, take advantage of longer terms with higher interest rates and not miss out on short-term high investment rate opportunities.
Saving Smart with a CD
A CD calculator helps take a lot of the guesswork out of shopping for CDs and comparing different financial institutions. While there are many financial products available on the market, a CD is an excellent choice for individuals that want to earn interest in an FDIC insured product over a fixed term.