Certificates of deposit (CDs) are short- to mid-term instruments that pay an agreed rate of return in exchange for holding for an agreed term. CD rates paid are generally half a percent higher than the money market fund or money market account. For some this is the deciding factor in purchasing. Unlike money market funds, CDs insure clients' money up to $100,000 through the FDIC.
Most certificates of deposit charge a penalty for early redemption. If the goal of your emergency fund is to provide immediate cash in the event of a job loss or medical illness, CDs are not an appropriate investment since terms are longer than thirty days. If you are serious about an emergency fund, then the certificate of deposit isn't for you.
This type of interest-bearing vehicle is useful when looking to produce a reliable stream of income. Most professionals recommend that clients "ladder" their certificates of deposit so that they take advantage of long-term interest rates while ensuring a certain amount comes due each year in the short term. The best way to do this is to buy three-year, two-year and one-year certificates of deposit and as the terms mature, reinvest the proceeds in three-year terms. This way you earn mid-term rates but maintain some short-term flexibility. It's best to consult with a professional if you're unsure how to make this happen.
The following is a checklist of things to look for when purchasing certificates of deposit:
If you have a very large sum of money to invest, a jumbo CD is a wise option to consider. The minimum deposit for a jumbo CD is usually over $1 million, and the interest rates are correspondingly larger. Jumbo CD rates are often above 5%, and the interest may be compounded quarterly or monthly depending on the institution. These CDs are usually bought by businesses or corporations looking for low-risk investment vehicles.
Certificates of deposit are a useful fixed-income investment but make little sense for your emergency fund. A rule to live by: if you can't get your hands on your money within a week, it's not suitable for your emergency fund.