In today’s world, one of the safest ways to make your money grow is through certificate of deposit or CD banking. A certificate of deposit can be thought of as a savings account but it is different in several ways. The most important difference is that a certificate of deposit can offer higher interest rates. The main concept behind a Discover Bank CD is that the financial institution that you purchase it from will give you an attractive interest rate provided that your money is kept with them for a fixed term.
How CDs Work
Certificate of deposit or CD banking is based on two key components when it comes to investing your money. The first is the interest rate and the second is time. Basically, financial institutions such as banks or credit unions offering CDs will take your money for a fixed term with the agreement that it will pay you interest on the term’s maturity date. You get a higher return on your CD if you buy it for a longer period of time.
Advantages of CDs
The main advantage of a CD is that it typically yields a higher interest rate as compared to traditional savings accounts. The interest rate is also locked in and does not fluctuate during the term whereas a savings account will.
Another advantage of CDs is that they are very safe and not considered a risky investment at all. The return on your CD at maturity is fully disclosed and all you must do is wait the fixed term to receive it. Plus, CDs are fully insured by the Federal Deposit Insurance Corporation (FDIC).
CDs also provide a way to save for those who have difficulty leaving their money alone so that it can accrue interest. Traditional savings accounts allow too much easy access to funds thus those without discipline in saving will probably never see any yield.
What to Consider Before Buying a CD
Before investing your money into a CD you must make sure it is an amount that you can get by without. Remember that the way CDs work is by holding your money for a fixed term maturity period. Withdrawing it prior to the maturity date will result in a penalty. The penalty might be the accrued interest at the date of withdrawal or, worse yet, the interest that would have been earned at the end of the term. The latter case could result in a penalty that reduces your principal or initial investment.
Another consideration to make before investing in a certificate of deposit is the current volatility of the market in general. In other words, if you foresee that market interest rates on CDs will rise in the near future, it might be wise to buy a CD for a shorter term so that you can take advantage of a higher rate in the future. The shorter term allows you to reinvest into a new CD with the higher yield.
One more thing to think about when trying to determine the term of a CD is when it comes to refinance & interest on existing loans you may have. Only you know your situation but it may be advantageous to use a technique known as laddering (explained below) so that you have cash available if you need to take advantage of favorable refinance & interest rates on a personal loan or home mortgage.
Yet another consideration to make is the type of institution you are buying your CD from. Traditional banks and thrift institutions such as credit unions both offer CDs. However, you may be able to get better rates from thrift institutions since they have access to funds at a lower cost from Federal Home Loan Banks. On the other hand, banks can probably offer more options when it comes to CDs.
Getting More from Your CDs
As mentioned before, one of the considerations you must make before investing in a certificate of deposit is if you can do without the money for the term. During that term, you cannot take advantage of any new opportunities to purchase a CD at a higher rate. There is a way to get more out of the amount that you wish to invest over the long run and still have access to your money at predetermined intervals. It is called CD laddering and it is way for you to get higher returns on your CDs plus it gives you more control over your investment.
Let’s take a simple example of how CD laddering works. Say that you have $4,000 that you can do without and would like to make that money grow in a CD. However, you do not want to tie your money up too long so you opt for a 3-month CD at an interest rate of 1.75% and compounded monthly. After 3 months, the payout on maturity would be $4,017. Let’s also say that you want to do this over a two-year stretch so you re-invest into another 3-month CD at the same rate. Re-investing your $4,000 every 3 months over a two-year period will result in a final payout of $4,137—a $137 profit.
On the other hand, you could take your initial $4,000 and divide it into 4 CDs at different maturity periods of 3, 6, 9, and 12 months. The yields on these might be 1.75%, 2.0%, 2.25%, and 2.5% respectively. So, you take $1,000 and buy a CD for each different maturity period. This means that every 3 months, you regain access to your money plus receive interest. For instance, at the end of 3 months, $1,000 will result in a payout of $1,004. Then, as each CD matures, you re-invest your payout into a 12-month CD. You will realize a payout every 3 months over your two-year period and at the end of that period you will have earned a total of $156 in interest. This is $20 more than you would have received by just rolling $4,000 into 3-month CDs over the same two year period.
Now, the previous figures are small in order to simplify the comparison. Consider how much more you can make when investing amounts such as $10,000, $50,000, or even $100,000.
In conclusion, CDs are a very safe and attractive option for making your money work for you. Furthermore, by using the laddering method, you can take advantage of the most this financial instrument has to offer. Start shopping today for the certificate of deposit or CD that is right for you and it will help you realize your financial goals.
