In the interest of giving you a full financial picture, here's the basics of a certificate of deposit and when it's time to put money where you can’t touch it.
Opening your first checking account is a rite of passage for many Americans. Although your parents might start a savings account for you when you’re a kid, chances are you won’t open a checking account until you have a job that earns you money.
We believe that reward checking and savings accounts like Kasasa outperform CDs (Certificates of Deposit), but in the interest of giving you the full financial picture, here's a little more on the basics of a CD. When might it be time to put money away where you can’t touch it?
CD basics you should know
A certificate of deposit (CD) is a low-risk investment vehicle. Basically, you buy a CD for a set amount of time, usually 18 months at a minimum and up to six years at a maximum, at a set interest rate. The bank holds and uses the money during the term, and at the end of the CD’s duration, it returns your principal and the interest you earned on it.
CDs are very secure investments that pay a decent rate. With stocks, rates are higher because the risk is greater — you could lose. With CDs, you’re guaranteed to gain at least something on your initial investment.
Signs it’s time to begin investing in CDs
When and why should you buy your first CD? How do you know it’s time?
1. You have money left over
Every month, you easily pay all your bills on time. Your emergency fund is in great shape, and you’re consistently saving for retirement, yet you still have money at the end of the month that you just don’t need right now. Good for you! Go open a CD and let that extra money accrue for a few months.
2. You have the time
Well, time plus that extra money. Since we’ve established you have the funds to do it, do you have the time? In other words, are you likely to need that money any time soon? Or can you afford to let it sit untouched for a few months, a year, or a few years? Generally, the longer the term of your CD, the higher the interest rate offered, and the more money you can make on it. Keep in mind, you'll pay a penalty if you withdraw the money before the end of the agreed-upon time frame.
3. You want to get your feet wet
You’re just learning about investing and you’re not quite yet ready to plunge into a big risk. Investing in CDs is a way to begin learning the basics of investing, interest, how to hold on to a security until it pays off, and the uplifting feeling of seeing your money grow. You'll just have to have a little patience.
4. You can’t refuse a great offer
Your bank may offer you a can’t-refuse CD deal. Perhaps it’s a great interest rate on a shorter-term CD, or an even better one on a longer-term rate. Look at the APR (annual percentage rate) and the APY (annual percentage yield). The APR tells you how much interest the bank is offering, and the APY tells you how much you’ll earn in compound interest over the life of a multi-year CD.
CDs can be a valuable component of an overall investment portfolio, no matter your age. Full disclosure: We believe (and the math proves) that CDs are not in your best interest compared to reward checking, but what's your opinion?