Investing options series: certificates of deposit (CD)

Certificates of deposit (CD) what is this?
A certificate of deposit (CD), also known as a "deposit", is a special type of deposit account with an interest rate higher than a regular savings account and federally insured. CDs are available in most banks, savings institutions and credit unions. They come in almost any denomination from $ 1 (at popular online banks only).



How does it work?
When you deposit money in a CD, you invest a fixed sum of money for a certain period of time-typically six months, one year, five years or more. In return your deposit, the bank pays interest, usually at regular intervals. Most of the buyers of CDs can arrange to have the interest periodically mailed to them or directly deposited into the account of another; However, this reduces the total return on investment, why waste your interest compounding.



When cash or redeem your CD, you receive the money originally invested plus any accrued interest. But if you redeem your CD before it matures, you may have to pay an "early retirement" penalty or forfeit a portion of the interest you earned. Unless you can get a significantly higher return somewhere else, you may want to avoid any premature withdrawal of your CD deposit.



When approaching the end of the term CDs, Bank or Credit Union probably will contact you regarding how you want to proceed with your CD. Most banks allow you to take the principal with your accumulated interest or roll the principal and interest on a new CD.



Different flavors
In general, CDs are classified according to their size. CD larger than $ 100,000 are called "Great CD" or "Jumbo CD" and less than $ 100,000 are known as "Small."



A callable CD is similar to a normal CD, except that the Bank reserves the right to redeem (or "call") your CD. Due to the uncertainty of these kinds of CDs usually command a premium interest rate. The only time that a bank will usually call a CD is when he tries to protect against a fall in interest rates. For example, if your CD rate is 4.5%, but interest rates fall to 2.5% so the Bank is paying for more than was received by their investments and thus losing money by continuing to pay high interest rates.



The latest "flavor" of the CD is actually an investment strategy called "laddering." In almost any kind of investment interest rates are going to be higher the longer you have to wait for your money. However, if it crashes into a high rate for 5 years and the increase of interest rates market within that time frame, your "high level" is not going to be worth much. The laddering tries to draw major interest rates associated with long-term investment, but also to avoid being blocked by rates when market rates rise.



For example, a 3 year laddering strategy would start by purchasing a CDS of term of 1 year, 2 years and 3 years. Every year, as one of the CD reaches maturity, you can invest in a 3-year benefit of higher interest rates. After 3 years of this cycle, all your money will be invested in 3 years but CD 1/3 of your investment will be ripe each year-allows you to reinvest in a new CD. Using this investment strategy that you can benefit from interest rate increases while enjoying the highest rates associated with long-term investments.



For help coming up with BankRate.com, laddering strategy has a great little calculator at http://origin.bankrate.com/brm/savings-advisers/cd-ladder.asp which gives the conservative, moderate laddering strategy and aggressive. When I run the calculator for a fictitious investment, the laddering helped me earn $ 600 more.



Investment in the short or long term?
In general, CDs are considered a short-term investment, due to the fact that typical CDs are available in 3 months to 5 years. However, the CDs are not as fluid as a savings account or money market accounts also due to their fixed period of time. Best use of a CD is saving for a certain period of time in the future as a car purchase in two years.



Potential risk
The biggest risk with a CD is his ability, at some banks, to be called. However, avoiding a callable can be as easy as talking to your own financial institution or by reading the brochure "the truth in savings" Bank is required to provide.



Since CDs are a deposit account, similar to money market accounts, they are insured by FDIC for $ 100,000 ($ 200,000 if investing with a joint account) and so I'm pretty "risk-free."



Potential return
It is probably safe to say that CDS are the best savings option in the short term due to their higher rates of interest. For example, one of the best deals right now on CD is ING Direct. Their CD "Orange" of 12 months has a return of 5.25% today compared to 4.25% APY on their savings account.



This is a good investment for?
Who has free time. Investments always favor those who are willing to wait for their money, and CDs are not exceptions. Thanks to the influx of online banks like ING Direct, someone with $ 1 to their name may invest in a CD-until they're able to wait 3 months or more. If you're saving for a specific reason in the near future a CD might be the best way to get the most for your investment, but also to help the discipline in savings since you won't be able to withdraw your money (without heavy fees).

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