When Should You Invest in a CD?

Certificates of deposits, better known as CD’s, are an investment option that I’m pretty familiar with.

Over the last several years I’ve helped my Grandma keep track of her finances and pitched in to help with the financial management of her businesses as well.

She tells me what she wants done and I execute. And, she is a HUGE fan of CD’s.

But why?

Certificate of Deposit 101

A certificate of deposit is pretty much a loan you make to the bank.

You agree to give the bank a certain amount of money for a specific period of time. In return the bank gives you interest on your money that is typically higher than what you would receive from a savings account.

The bank can then use your money in any way they like – they often use your deposit to loan other people money. Therefore, the interest rate you receive on a CD is largely determined by the going interest rates on mortgages and personal loans.

However, unlike a savings account you do not withdraw your deposit whenever you want. If you do decide to make an early withdrawal from your certificate of deposit you’ll face a pretty hefty penalty.

When It Makes Sense to Invest in a CD

There are a few instances when it makes sense to invest in a CD

•  You are only looking to invest for a short period of time
• You’re nearing retirement age and need low risk investments
• Interest rates are high

With interest rates being so low right now it’s a very inopportune time to invest in CDs. If you are looking for a short term investment, say six months to a year, then CDs could be a good option.

Also, for those nearing retirement CDs are an attractive option carrying almost no risk since most banks are FDIC insured.

I personally like the thought of investing in CDs for the short term. Here’s an example:

Say I’m saving up for a down payment on a house and I have $20,000 right now but it will take me another two years to get where I want to be. Why not put that $20,000 I have in a CD for 12-18 months?

It would ensure that I didn’t touch the cash I had on hand and I would earn interest on my money in a relatively safe way. Can’t beat that.

When It Doesn’t Make Sense to Invest in CDs

If you are young and starting to save for retirement CDs make very little sense as an investment strategy. The interest rates are so low that you’ll see very little return on your money. There are several other investment options that would make much more sense for you.

Final Thoughts

So why does my Grandma invest her money in CDs?

She’s retirement age. She does still actively work by choice but now is not the time for her to be taking risks with her money.

As far as her business, CDs are a safe option. If she has excess cash in the business account she can park some of that money in a CD and earn a little bit of interest. When the CD is up for renewal she can then take the money and use it for her business or let the CD renew and earn some more interest.

What’s your take on CD’s?