Certificates of deposit or CDs have proven to be an opportunity for those interested in low-risk investment in near future. They may be interested in buying a car or make a down payment on a house pretty soon.
If you do not need your cash reserve immediately, you’ll likely want that money to earn a better rate of return than your checking account offers, and that too, without much risk. This is when CD has an important role.
You should take into account two factors when considering the right CD for yourself:
- Determine when you are going to need the cash and identify if you have other resources to resort to when required. If yes, then, CD could be the option to explore.
- The anticipated direction of interest rates will help you determine how long to tie up your money. If rates are rising, a short-term CD may be best. If rates are falling, a longer-term CD may earn you more money, since you’ll lock in a higher rate.
How to Invest?
You should follow two numbers before you shop for a CD:
- APR or the Annual Percentage Rate, the interest rate on CD offered by bank.
- APY or the Annual Percentage Yield, which tells you what you’ll earn over the multiyear life of the CD as your money compounds.
What to do next for your CD investment?
- Determine for how much time you want to tie up your money. This will depend on your anticipation regarding when you are going to need the money or whether you have other cash assets for the purpose till the CD matures.
- Decide the kind of CD which best suits you purpose. For example, if you want to invest for two years and don’t want the risk of being stuck with a low rate, then a bump-up CD may be ideal. Consider a liquid CD if you are afraid that you’ll need part of your deposit for an emergency.
- Find out the rates with different banks once you are final with the duration and CD type.
Consider a ladder
‘Laddering’ is one of the techniques to reduce a CD’s drawbacks. Using this simple technique, you will have regular access to part of your cash and will be protected against rising interest rates. Under ‘laddering’, you divide your lump sum equally and invest it in different CDs of varying durations instead of investing one big chunk in single CD.
Advantages of laddering:
- Penalty-free access to cash on each CD maturity.
- More favourable interest rates, since you’re always investing in a longer-term CD.
- Better returns if interest rates are higher when you re-invest.