Should I Invest in a CD?
What is a CD?
A certificate of deposit, or CD, is a type of savings product. You deposit a fixed amount of money into the account and agree not to withdraw it for a certain period of time. In exchange, the financial institution locks in an interest rate for the term of the CD. At the end of the term, you get your principal back plus accrued interest. If you cash it in before the maturity date, you may be assessed a significant penalty for early withdrawal.
What are the Advantages CD?
Certificates of deposit are easily obtained at your local bank or credit union. They are available in various amounts and durations and offer a fixed rate for a specified time period. CDs are also insured up to the guidelines of the FDIC or NCUA. They generally offer better interest rates over a regular savings, checking, or money market accounts.
What are the Disadvantages of a CD?
Interest Rate Risk: One of the biggest disadvantages of a CD is that it is fixed for a period of time. You could lock in a CD for 2 years at 2% only to see rates go up to 3% or 4%. You do not get the advantage of the increase in rates. Now imagine you lock in a CD for 2 years at 4%. You may feel pretty good as rates drop to 2%. However, when that CD matures, the bank is likely not going to continue it at 4% … you’ll be offered the then current rate of 2%.
Lack of Liquidity: Another drawback to a CD is that you will be charged a penalty, which could be significant, if you withdraw your money before the maturity date. In general, a certificate of deposit would not be a suitable place to keep your emergency fund or to cover daily living expenses.
Automatic Renewal: Most bank contracts are written so that the certificate of deposit will automatically renew at the maturity date unless you notify them within a certain grace period. You may not receive an attractive interest rate at renewal and will be locked in for another term if you do not cash it in within the allowed time.
Taxable Income: Interest on the CD is taxed as ordinary income. There are other safe alternatives that provide a similar return that could be state or federally tax free.
How Can Professional Financial Management Help Me?
The core of our financial planning services is getting to know our clients individually. We review your cash flow and suggest ways that you can save that may produce higher returns as well as be more tax efficient. We can help you determine a comfortable amount for an emergency fund as well as how to strategically allocate your retirement savings for the long run. Call us today to learn more about how we can help you plan your financial future.
