Advantages and Disadvantages of Investing in a Certificate of Deposit

by Chris Joseph, Demand Media
    Certificates of deposit offer investment safety but little liquidity.

    Certificates of deposit offer investment safety but little liquidity.

    CDs are great for listening to music while driving in your car. However, there is another CD variety that won't necessarily fit well in your CD player that's known as a certificate deposit. This type of CD is an investment product that is available from banks as well as brokerage firms. CDs offer a number of potential benefits and pitfalls to carefully consider before investing.

    Predictability

    If you're not the daring type when it comes to your money, CDs offer the benefit of predictability. CDs are purchased to cover a set time frame, which could range from six months to several years. At the end of the time period, the CD matures and you receive your original investment plus any accrued interest. Some CDs pay out the interest at fixed intervals during the investment term. In many cases, CDs feature a fixed interest rate, so you will know exactly how much money you will receive at maturity even before you invest. However, more complex CDs offer features, such as variable interest rates are also available.

    Safety

    Another advantage of certificates of deposit is that they make a good investment choice if safety is a primary concern. CDs that are purchased from banks are typically covered by the Federal Deposit Insurance Corporation, which provides individual investor coverage up to an aggregate of $250,000 per bank. This differs from investment vehicles, such as individual stocks or mutual funds, where your original investment of rate of return is not guaranteed.

    No Liquidity

    A major disadvantage of CDs is that they are not liquid investments, meaning you can't withdraw your money before the end of the term. If you do, you'll be assessed a substantial early withdrawal penalty or have to forgo some of your accumulated interest. You may also miss out on other investment opportunities where you could earn a greater return on your money because your cash is tied up in your CD investment.

    Low Returns

    While CDs generally offer a better rate of return than bank savings account, they probably won't do as well as other investment products over the long haul. Bank CD interest rates normally fail to keep up with the rate of inflation so your money will lose its purchasing power, particularly if you purchase CDs offering longer terms. As a result, CDs often make the most sense if you want a safe place for your money for a short period of time.

    About the Author

    Chris Joseph writes for newspapers and online publications, covering business, technology, health, fitness and sports. He holds a Bachelor of Science in marketing from York College of Pennsylvania.

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