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Savings accounts aren’t the only option you have when saving for the future. A Certificate of Deposit (CD) can also help you reach your goals. CDs come with fixed interest rates, so you’ll know exactly how much you’ll earn on each deposit. You may even get a better interest rate than a regular savings account.
At American Savings Bank, we’re here to provide you with a safe and secure way to grow your savings. Read on to learn more about CDs and how to get started saving today.
A certificate of deposit (CD) is a type of savings account with a set interest rate and a specific withdrawal date. This means you’ll earn a fixed amount of interest, compounded daily, over a set number of days, months or years. When your CD reaches the end of the set period, called the maturity date, you can withdraw your initial deposit and the interest you’ve earned.
ASB and other banks offer fixed interest rates on CDs because you agree to keep your money in the CD account until the scheduled date of withdrawal. Unlike a normal savings account, your CD interest rate does not fluctuate. Keeping your money in the account for a set term also makes it easier for banks to offer higher rates than regular accounts.
It’s important to be careful with CDs, as taking your money out before the maturity date could result in early withdrawal penalties. It’s best to plan ahead when opening a CD: consider using a separate savings account as a rainy day fund in addition to your CD, so you’ll still have access to cash in case of an emergency.
Rate: The fixed interest rate you’ll earn during the length of your CD.
Term: The set period of time you agree to keep money in your CD.
Maturity Date: The scheduled end of your CD term. You can withdraw your money without early withdrawal fees starting on this date.
Minimum Deposit: The minimum initial deposit to open a new CD.
Principal Deposit: This is the amount of your initial deposit into your CD. You can usually deposit any amount over the minimum required deposit.
Withdrawal Penalty: The fee you may incur for withdrawing money from your CD before its maturity date.
Jumbo CD: A special type of CD designed for large deposits.
Annual Percentage Yield (APY): The rate of return taking into account the effect of compounding interest.
Like any type of financial account, CDs come with advantages and disadvantages. It’s a good idea to weigh the pros and cons of a CD before you open an account.
Pros:
Higher Returns: CDs generally have a higher rate of return than a regular savings account.
Fixed Interest Rate: The interest rate of a CD is fixed, meaning it won’t change over the course of the term.
Safe Investment: A CD is often one of the safest investments you can make. They provide a guaranteed return and are federally insured.
Range of Terms: Most CDs offer a wide range of terms.
Cons:
Limited Access to Cash: Your money will need to stay in the CD account until the maturity date to avoid paying an early withdrawal fee.
Risk Rising Interest Rates: You could end up with a below-average interest rate if rates increase during your CD term. However, having guaranteed earnings could outweigh the potential rise in interest rates.
CDs are a low-risk savings option that can help most people save for the future. You might want to consider using a CD, instead of a traditional savings account if you:
Have a Specific Savings Goal: Are you saving for a new car, down payment on a home or just a new set of furniture? A CD is an easy way to save for the future while earning fixed interest on your savings.
Won’t Unexpectedly Need the Money: A CD is a good option for saving if you already have a separate savings account for emergencies.
Are Risk-Averse: You could potentially see higher returns by investing your money into stocks or bonds. However, those investments could be volatile and risky. Investing in a CD is a safe option for risk-averse investors.
Wondering how much you could earn from a CD? Try our CD calculator to get a better idea of the growth potential of your initial deposit.
Ready to open a CD? Apply online today or make an appointment with one of our helpful bankers to get started!
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Mapping out plans to build your savings can be challenging, especially when interest rates fluctuate. A certificate of deposit (CD) is a good alternative if you’re risk-averse when it comes to investing.
A CD is a type of savings account that allows people to earn interest at a fixed rate often higher than what’s available with traditional savings accounts. However, CDs can also have some downsides given the requirement of holding funds for a set term. These are a few things to consider for those weighing if a CD is right for them.
With a CD, you get a fixed interest rate for a fixed period. After the CD’s term is up, you’ll have access to the deposited funds and interest earned.
According to Brad Stark, certified financial planner and co-founder of Mission Wealth, a wealth management firm in Santa Barbara, California, you can purchase CDs in brokerage accounts to help with simplicity. Many brokerage firms, such as Fidelity, have relationships with different banks, allowing people to spread their money around without opening various accounts.
By buying CDs, Stark explains that people are essentially making a promise with a bank. That promise is providing funds to an institution in exchange for being paid back with interest later.
“It’s a loan you’re making to the bank for a set period of time,” Stark says.
CDs are appealing for many reasons: they’re relatively safe investments, offer stellar APYs, and come in a variety of different term lengths.
While it’s true that you’ll get a higher annual percentage yield (APY) with a CD versus a traditional savings account, it’s important to consider timing or when you plan to open a CD. If you open a CD when the federal funds rate—or the Fed’s benchmark rate—is low, you won’t rake in as much interest as you would if interest rates were higher.
Another factor you’ll want to pay close attention to is your investment time frame.
“As you commit your money to longer periods of time to lock it up, you should be compensated with higher interest,” Stark says.
However, this doesn’t always hold true. Right now, the yield curve is inverted so most longer-term CDs are offering higher APYs than shorter-term ones.
If you open a CD or share certificate at a bank or credit union that’s insured by the Federal Deposit Insurance Corp. (FDIC) or National Credit Union Administration (NCUA), respectively, you’re insured up to $250,000 per depositor, per financial institution in the unlikely event of a bank failure.
CDs have durations ranging from a few weeks to many years, so you’ll want to choose one that matches your investment horizon—whether it’s for a down payment years down the line or cash you need in one year.
As of January 2024, the national rate for a 1-year and 5-year CD is 1.86% and 1.41%, respectively. While these rates aren’t stellar, you can find CDs that boast generous APYs by shopping around.
These financial institutions often offer rates above 5%:
One method to consider is placing money in multiple CDs rather than just one; this is known as a CD ladder. Scott Van Den Berg, a CFP at Century Management, says building out a portfolio of CDs can have major benefits.
Here’s how it works: You split your cash up between multiple CDs of different term lengths and when they mature, you reinvest the money into new CDs. This helps create a cascade of liquidity, with each CD maturing at a different time. With the extra liquidity, you can deal with unforeseen expenses more easily without tapping into your money early.
“[CD laddering] gets you that money back, and you can then just reinvest it,” Van Den Berg says.
CDs aren’t the right choice for everyone. CDs may offer little liquidity, meager returns, and no tax benefits.
CDs can be a way of playing it safe. By opting for a CD over a more lucrative yet risky asset like stocks, there’s an opportunity cost. This is particularly important to consider if you haven’t reached retirement age. “If you’re 85 or 90 years old, you want all your money to be safe and your time horizon is really short, you could put CDs in an IRA [individual retirement account],” Stark says. “If you’re 40 years old, and you have an IRA and CDs in there, what an opportunity you’re missing.” Plus, the time agreement of a CD can be inconvenient if someone is unable to hold the funds there for the duration of the agreement.
Both Stark and Van Den Berg noted other areas where it’s possible to have stronger investment growth than with a CD.
Stark suggests considering stocks in a diversified portfolio if the time horizon for your financial need is longer than 7–10 years. “While this path is volatile, time tends to heal most short-term investment wounds,” Stark says. “Where time is the enemy to CD investing.”
Whenever you invest in a CD, you lock in the interest rate for the term. If inflation rises during the term, your APY won’t be adjusted, so an interest rate that once seemed stellar might be lackluster after accounting for inflation.
“Inflation really took a toll on you and your interest went from double digits to zero,” Stark said. “In the meantime, prices … went higher so your purchasing power just got decimated.”
You’ll have to pay federal and state income tax on interest you earn on traditional CDs. If you’ve earned $10 or more in interest on a CD, then those earnings must be reported. If the CD has a term longer than a single year, then you must pay taxes on the interest accrued each year.
When you sign up for a CD, you agree not to touch the money for a set period of time but there are always unexpected expenses. If you access your money before the CD’s term is up, you’ll be charged an early withdrawal penalty, often worth a few months of interest.
A CD can be the right move if you have a low-risk tolerance and a shorter investment horizon.
To avoid the early withdrawal penalty, forecast your expenses and make sure you can commit to not accessing the funds for the entire term length. Remember that CDs aren’t the only option out there; take the time to explore other investments and create a well-diversified portfolio.
For some people, it can be worth putting money into a CD. If a person is seeking a riskless investment with a modest return, CDs are a good bet—you’ll earn a higher rate than you would with a checking or savings account, but you’ll have to commit your funds for a fixed period.
An IRA is a tax-advantaged investment account. Typically, investors can own stocks, bonds, CDs, and other assets through their IRA. In contrast, a CD is a deposit account where investors commit their money for a fixed period in exchange for a fixed interest rate. Typically, CDs don’t offer any tax benefits. An IRA is probably a better option if you’re saving for retirement, but a CD is a good bet if you’re not investing for the long haul.
The amount you earn on a $10,000 CD in a year depends on the APY and your federal, state, and local taxes. Hypothetically, if you deposit this amount into a CD with a 5% APY you will earn $500 minus the appropriate taxes.
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