Certificates Of Deposit

Supercharge your emergency fund

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:

  • When does it mature? The last thing you want is to own a 15-year certificate of deposit when you'll need the funds in five.
  • Does it have any call features? The issuer of the CD can establish a date when they can repay the funds to you. At that point, you'll need to find another CD.
  • Who is the issuer? It makes a difference. If you already have CDs with a particular institution, you want to make sure that amount does not exceed $100,000. If it does, you've left your funds uninsured.
  • Understand the penalties for early withdrawal. They can be substantial, so take them into consideration before purchasing.
  • Make sure you understand the rate of interest paid. CD rates often depend on the amount of your deposit. The more you deposit, the better the interest rate will be. In order to get an advertised CD rate, you often have to meet a minimum deposit amount. Many people end up earning something other than what they expected by making an assumption. Read the paperwork thoroughly and if you're uncertain, don't hesitate to ask for clarification.

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.

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