Managing a household budget can prove tricky, and while much of your income might pass straight through your accounts to your daily and monthly expenses, you should aim to maximize what remains by creating a savings plans. Certificates of deposit are a type of conservative long-term savings account. The interest rates on CDs are usually higher than on basic savings accounts, but most banks have rules that prevent you from having easy access to the money. Also, in the long-term, CDs do not tend to offer the same kind of growth potential as stocks and other securities. Carefully think about a number of factors, including your short-term costs and long-term plans, before you invest in CDs.
Financial planners often produce charts for clients in which the client's financial assets are divided into three buckets: short-term, mid-term and long-term. Typically, advisers recommend keeping between three and six months of living expenses in highly liquid accounts such as your checking or savings account. You can readily access this money when your car breaks down, you lose your job or experience some other type of calamity. The long-term bucket holds the money you plan to invest for a decade or more and these funds might form part of your retirement plan or even cover college costs if you eventually have kids. The mid-term bucket contains money that you do not need now but do not want to tie up long-term. CDs are instruments that belong in the mid-term bucket, so once you've divided your money into these three increments, you will know how much you can consider investing in CDs.
CDs available through banks are guaranteed by the Federal Deposit Insurance Corporation. This means that if your bank fails, the FDIC will cover up to $250,000 of your money. The National Credit Union Administration provides the same coverage for CDs held through credit unions. If you are wary of a bank failure, then split your money between several institutions to ensure that you remain under the FDIC or NCUA cap at each institution. You can further extend your coverage by acquiring bank issued CDs through an investment company and holding those CDs in your brokerage account.
Banks use CD money to fund lending and consequently banks take steps to reduce the likelihood that CD clients will remove their funds before the end of the CD term. Institutions may assess penalty fees or withhold your interest if you withdraw your funds prematurely. Additionally, banks typically pay tiered interest rates on CDs which mean that the more you invest in a CD the more you stand to earn in interest. Your bank's minimum-balance requirements, interest rate tiers and withdrawal penalties should have a major influence on decisions related to the size of your investment.
CDs are not ideal investments for everyone, so these products do not necessarily have to form part of your investment portfolio. If CDs appeal to you but you are wary of tying up your money, you can ask financial institutions about so-called no-risk CDs. These accounts work similarly to standard CDs except that you can make penalty-free withdrawals prior to the end of the term. If you can access your money with minimal restrictions then decisions about the size of your investment are much easier to make.
- FDIC.gov: Certificates of Deposit: Tips for Savers
- SEC.gov: High-Yield CDs – Protect Your Money by Checking the Fine Print
- The Wall Street Journal: What is a Certificate of Deposit (CD)?
- Virginia Co-operative Extension; When the Storm Passes; Managing the Farm Family’s Living Expenses
- SEC.gov: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing