Investing in CDs is a great way to get your feet wet in the world in investing because they are low risk. They are great for preserving your cash and minimizing the affects of inflation. That doesn’t mean CDs are without risk. When investing in CDs make sure you read the fine print and have a full understanding of what type of CD it is. Below we go over some tips for investing in CDs.
Know How CDs Work
When you purchase a certificate of deposit (CD) you are lending a fixed amount of money to a financial institution for a specific amount of time. In exchange, the bank agrees to pay you interest on the CD. When the term is up you can cash in the CD and get your money back in addition to any accrued interest. You can redeem your CD before it matures, but you will likely be issued an early withdrawal penalty. CDs are FDIC insured to the money and interest earned are protected up to $250,000.
There are Different Types of CDs
The most common CD is a fixed-rate or traditional CD. These pay a fixed rate of interest for a specific amount of time. However, more financial institutions are beginning to offer various types of CDs in order to entice investors. Many banks now offer a portfolio of CDs that have non-traditional features. For example, many banks are now offering liquid CDs with no early withdrawal penalty similar to a money market account. There are also certificates of deposit out there with variable interest rates that are set to change at different intervals so that investors can take advantage if interest rates go higher. These variable CDs are set to a fixed schedule or are tied to indexes such as the S&P 500or Dow Jones.
Opening a CD Account at a Bank
The most common way to invest in a CD is to open up an account at a bank. The CD is offered directly to you from the bank. You are responsible for knowing the terms after the banker goes over the details with you. You will want to make sure you understand all terms including whether the CD is FDIC insured.
Brokered CDs are offered through brokerage houses or agencies and are typically co-mingled accounts of several investors. CD investors with several thousands of dollars to invest in CDs may choose to invest funds through a broker at multiple banks, thus utilizing the FDIC insurance coverage at multiple locations to further mitigate risk. Also, brokers who invest large sums of money may be able to get higher interest rates because of the large amount of money to be invested. Before investing in a CD with a broker, make sure they are a legitimate broker as FDIC insurance does not cover fraudulent acts made by the broker or brokerage firm.
When investing in a CD, ensure that the deposit is FDIC insured. Never take the broker’s word for it. Not all banks are insured by the FDIC. You can check the FDIC’s website to find an updated list of insured financial institutions.
You also want to make sure the CD’s principal (original investment amount) is not subject to contractual risk. An investment is a CD only when the issuing bank agrees to give back the full original amount investment once the CD matures. If there are contractual contingencies on the principal then the “CD” is not really a CD and is not insured by the FDIC. Make sure you understand these stipulations as well as double checking the maturity date of the CD.