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Looking for a safe place to invest your dollars, an investment vehicle with a guaranteed rate of return? A bank-issued certificate of deposit -- usually known as a CD -- might be a good choice.
Be aware that CDs, despite their safe nature, are not perfect investment vehicles. You'll tie up your money for a potentially long time. Also, the rate of return might not be as high as it could be with other investments.
Here are some factors to consider before investing in a CD:
What They Are
Banks typically offer CDs as low-risk investments. However, when you invest in low-risk investments, your rate of return is often lower, and that is often the case with these types of accounts. If you are interested in investing in a CD, you can simply walk into a bank and deposit your funds into one.
CDs are typically available covering differing periods of time. One CD might require that you keep your dollars invested for three months. Another might require that you keep them invested for a year or more. If you withdraw your money before this period ends, you'll face withdrawal penalties. Make sure, then, that you can keep the money you place in a CD for as long as your financial institution requires.
When you invest in a CD, you’ll receive a guaranteed interest rate. This rate is usually higher than the rate offered on traditional savings or checking accounts or with money market accounts. However, CDs still offer a relatively low rate of return when compared to investment vehicles such as bonds, stocks, and mutual funds.
Once your CD reaches its end date -- known as maturing -- you'll receive your original deposit back along with the interest that this deposit generated. Remember that the interest earned on a CD is considered taxable income.
The Advantages of a CD
The main advantage of a CD is the stable nature of the investment. Deposits in a CD of $250,000 or less are insured by the FDIC, so even if your bank falls into financial ruin, you will not lose the money you've invested.
You also know that your rate of return is guaranteed. This means that you’ll know up front the interest rate that you’ll be earning on your CD. There won't be any unpleasant surprises -- or any surprises at all -- once your CD matures.
The Disadvantages of a CD
CDs, though safe, are not perfect investment vehicles. They do come with some disadvantages.
First, you'll be tying up your investment dollars for a potentially long time, as much as a year or more. You will not be able to access those dollars, whether to spend them or move them into a new investment vehicle, without paying a financial penalty.
However, the potentially bigger drawback is that CDs, despite their stable nature, don't boast exceptionally high rates of return. You will not lose money by investing in a CD, which is part of their appeal. However, you might not make as much money as you could have by investing in potentially higher yielding, less stable investment alternatives such as stocks, bonds or mutual funds.
Only you can determine if a CD is the right choice for you. It comes down to how much risk you are willing to tolerate when investing.
