Money Management Dos and Don'ts for Investing in CDs

Even the simplest money management strategy should include diversification. Nodiv should have all their wealth tied up in one type of asset, where a financial disaster affecting that asset could do major damage. Money management should involve choosing ways to save and invest that balance out your personal tolerance for risk and reward. One investment you probably haven't heard about much in recent years is the certificate of deposit, or CD.

What Are CDs?

A CD is a type of savings account that holds a pre-set amount of money for a fixed time period, typically six months, one year, or five years. The issuing bank pays interest over the term of the CD. When the term is up, you cash in your CD and receive your original investment plus interest. If you buy your CD through a federally insured bank, your CD and other accounts in that bank are insured up to $250,000 total. (In other words, the $250,000 insurance is on a "per depositor" rather than a "per account" basis.)

Risks and Benefits of CDs

CDs are simple and safe, but they don't get a lot of press. People shy away from CDs when they expect interest rates to go up. Who wants to lock a bunch of money away for five years at 2% when interest rates are expected to increase to 3%? When interest rates are low, rates on CDs don't look that great. They may be only a little higher than what's offered on regular savings accounts, and unlike your regular savings account, you can't take money out of a CD that hasn't matured without paying a penalty.

Other than interest rates increasing once you've locked money into a five-year CD, the biggest risk with CDs is what happens if you need to get that money out early. On average, the penalty for taking money out of a long term CD early is about six months' worth of interest. But Bankrate found that penalties can go as high as $50 plus 3% of the amount withdrawn, and that's enough to hurt.

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Why They're Looking Good Right Now

The biggest benefit of CDs is that you earn more than you would with savings, and they're very safe. They can be a great alternative for bond investors. Some online banks are offering five-year CDs with interest rates over 2%. If you wanted a 2.25% yield on a nice, safe US Treasury bond, you would have to buy a bond that wouldn't mature for seven or more years.

Are You a Good Candidate for Investing in CDs?

CDs aren't right for every money management strategy, however. CDs can be especially beneficial for people who are well-off already, people without children, and retirees. Wealthy people like CDs because they reward larger, longer term investments with higher interest rates, and wealthy people can afford to lock up more money for longer terms. Child-free people, who don't have to worry about the costs of raising kids, tend to have the financial freedom that makes CDs a smart part of their money management strategy. And retirees like CDs because they're safe at a time in life when taking big financial risks isn't wise. These aren't the only groups that can benefit from CDs. Depending on your money management position, they could be a good idea for you, even if you have kids or don't have a lot to invest.

Do Consider Investing in CDs If ...

Generally, CDs make better investment vehicles if certain conditions are satisfied that allow you to get the most from them. Specifically, CDs may be worth exploring if:

  • You already have a healthy emergency fund. CDs aren't good for emergency funds because of the early withdrawal penalties. Emergency funds should be in an account you can raid without penalties in an emergency.
  • You want a stable portfolio. Maybe you have some riskier investments and want to counterbalance them with stability. CDs can be good for this.
  • You're not worried about inflation. If inflation is higher than the interest rate you're getting on your CD, you'll be kicking yourself over your lost purchasing power. But if you're confident inflation will remain low, CDs can be good money management tools.

Whatever your money management style, you'll find Mint to be indispensable for tracking your bills, expenses, and investments. You can track all of your investments in one place, and with the Mint mobile app, you can do so wherever you go.

Next step: Sign up for Mint and track all your investments in one place.