Investors looking to grow their money want to know if CDs are still a good investment in 2012. Well, that depends on what you mean by “good investment.” It’s all relative. It really depends on what your investment goals are. If you’re looking to strike it rich with a minimal investment then CDs are not for you. But if you want a safe place to park your money and keep up with inflation then you may want to consider a CD.
There are several types of CDs. Let’s first take a look at what they are and then discuss if they are a good investment or not.
CD stands for certificate of deposit. They are low risk low return investments. You agree to purchase a CD for an existing period of time and the bank then agrees to pay you interest provided you leave the money in the CD for the entire term. CDs are among the safest investments a person can make because you are guaranteed to get your money back in addition to the interest once the CD matures. They are FDIC insured up to $250,000 so even if the bank goes under you are fine.
Traditional CD – You get a fixed interest rate for putting your money in a CD for a specific period of time. When the CD matures you can take your money and interest or roll it into another CD or investment vehicle. Withdrawing the money early will result in a penalty.
Liquid CD – One of the knocks against CDs is they are not liquid. A liquid CD allows an investor to make withdraws without penalty. The interest rate is slightly lower, but still higher than a money market account in most cases.
Zero-coupon CD – This type of CD reinvests the interest instead of paying it out. The result is a higher interest rate.
Callable CD – These CDs can be recalled by the bank after a specific period. A bank may do this if the interest rate falls well below the initial rate. These types of CDs generally have higher interest rates and are offered through brokerages.
The downside of CDs has always been the low interest rate. If the Federal Reserve keeps rates low then the interest rates will stay low. Most of the time CD rates do not even keep up with inflation. CDs also tie up your money. So if you know you are going to need your cash soon then investing in a CD is probably not for you.
High yield CDs are the ones that take the longest to mature. And if the economy improves the Federal Reserve will raise the rates and you can make an even better return that beats inflation. If you have enough money to invest in CDs, at least $5,000, the best way is to ladder them. For example, you invest $1,000 in a one-year, $1,000 in a two-year, and so on until you get to the five-year CD. If you don’t want to invest by laddering you can find a CD that allows you to raise the rate if interest rates go up.
CDs aren’t for everyone. If you have a lengthy investment window and want a bigger return then you should consider a mutual fund. If you want liquidity yet still want to earn interest at a higher rate than a savings account, then a money market account is a good choice. CDs are great for parking your money in a safe investment vehicle and if you choose the right ones you can beat inflation. They are a great way to diversify your portfolio along with higher risk/higher return investments.