Last week, I discussed one method to store your money in a relatively low-risk manner while also maintaining liquidity and earning some (although low) profits. This was through money market funds. Today, I’ll be presenting an alternative to money market funds, the certificate of deposit. Certificates of deposit, unlike money market funds, require you to “lock” your money up for a certain predetermined amount of time. However, with this comes higher interest rates, meaning more potential profit.
A certificate of deposit, or CD, is a type of account offered by most banks that require customers to lock up money for a specific amount of time. This time can vary from very short-term, like 3 month CDs, to longer-term, ranging from 1-2 years, with some going up to 5-10 years, usually, the longest term offered. The term is the amount of time you must keep your money in the CD.
The longer the term, or lockup period, the higher the interest rates. Rates usually start from 0.4% and go up to around 1.1% for the longest duration CDs. While these rates may seem low, they are significantly higher than those offered by savings accounts and most money market funds.
While money market funds can be liquidated at any time, and turned into cash, CDs must be held for the duration of the term. However, if you absolutely need to access the money in your CD, you can pay a penalty and withdraw your cash. As such, CDs should not replace a savings account, as accessing the cash in a CD is not quick or easy, and can prove to be extremely inconvenient and potentially harmful in the case of an emergency.
However, putting your money into a CD can be beneficial if you're saving up for a large purchase, like a down payment on a home or car. You can earn interest and make profit, and still access your money within a relatively short time. CDs can be a safer alternative to investing in the equities markets, where downturns can be sudden and prolonged, and a more profitable alternative to money market funds.
In short, certificates of deposit are a way of storing your money for the short term while also generating profit. They are an alternative to traditional savings accounts and money market funds, offering competitive interest rates. However, they do require you to lock up your money for a specific amount of time, so you should have a separate emergency fund.