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Investing with Certificates of Deposit
Investing in the stock market can bring big returns — especially if you land on a hot stock before the public learns about it. However, investing in the stock market can also lead to big losses.
Saving your money is a safe bet, but most savings accounts have very low interest rates — if they pay interests at all.
Purchasing a certificate of deposit, or CD, is a safe way to invest your money and to get a guaranteed return.
What Is a CD?
A certificate of deposit is a savings certificate backed by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). CDs issued by banks are insured by the FDIC, and those issued by savings accounts are insured by the NCUA.
CDs are issued for a fixed term — anywhere from one month to five years — and pay an annual interest rate. Typically, the larger the principal you purchase, the higher the interest rate you can expect to get. While the highest interest CDs may still under-perform the stock market, they are considered a low-risk investment since they pay out a sure return.
In most cases, you cannot withdraw before it has reached its term without incurring hefty penalties. You also have to pay taxes on any dividends you receive when you cash it out.
Types of CDs
There are several types of CDs in addition to the traditional one, some of which allow you to withdraw funds early without penalty and some that offer flexibility in interest rates.
The different types include:
- Brokered CD: Though traditional CDs are purchased from a bank or credit union, these are purchased from a brokerage. Brokered CDs typically carry a higher interest rate, but you will have to pay a fee to buy them.
- Bump-Up CD: If interest rates rise for CDs of similar length, a bump-up CD allows you to swap out your CD for a newer one with the higher interest rate. You typically can only “bump up” once during the term.
- Callable CD: Banks can recall this type of CD at any time by paying you the original deposit and any interest you earned. Typically, banks recall a CD because interest rates have dropped significantly. However, callable CDs typically start with a higher interest rate to make them more attractive to buyers.
- Liquid CD: With a liquid CD, you can withdraw a portion of your deposit without incurring a penalty. This is a good choice if you want to ensure you have some access to your money in case of a financial emergency.
- Zero-Coupon CD: Instead of earning annual interest, this CD reinvests the earnings from your interest so you have a higher deposit and can earn even more interest.
Uses for Investment
Purchasing CDs is a great way to build income while protecting your savings. You will need to invest a sizable amount of money or to keep your money invested for a long time in order to make any significant returns. However, even small gains can help you to work toward your financial goals, such as saving for the down payment on a home or paying off your debts to build your credit.
Use the calculator above to find out just how much you can earn and how quickly you can build the savings you desire to meet your financial goals.