Not to be confused with a CD that blasts out your favorite 90’s throwback hits, a Certificate of Deposit (financial CD) is another great option for you to be aware of if you want to store your money somewhere extremely safe and gain a modest return.
Almost all banks offer financial CDs, and it is a financial product commonly sold by banks, thrift institutions, and credit unions. Financial CDs are similar to savings accounts in that they are insured “money in the bank” and thus, up to the local insured deposit limit, virtually risk-free.
How Does a Financial CD Work?
How a financial CD works is that you put money (with a minimum often of $500) in the account for a specified amount of time, in exchange for a guaranteed return on your money. It’s functionally similar to a savings account, with the caveat that you are not allowed to touch your money until the maturity date. The length of time varies – I’ve seen CD’s as short as 3 months to as long as 5 years. Typically, the longer you leave the money in the account, the higher the interest rate the bank agrees to pay you (though not always). The end of that time period is referred to as the “maturity date”.
When the financial CD reaches the maturity date, you will have the option to pull your money out of the CD or it will automatically roll over into a CD again at the current offered rate.
Banks will penalize you with early withdrawal fees if the money is pulled out before the maturity date.
Why Would You Want To Use a Financial CD?
This is money that does not need to be liquid (easily used at any moment’s notice), but you need this money to be extremely safe. I personally have a high-yield CD set up with what I consider to be a second emergency fund that I hope I never need to draw on, but is there just in case.
The way a lot of people will use a financial CD is by setting up what’s called a “CD ladder”. This is a good strategy to minimize risk while maximizing guaranteed returns.
Here’s an example of how this will work in action. Let’s say you have $4,000 that you want to put into your CD ladder. First, you research financial CD rates to find the highest returns for a 1-year, 2-year, 3-year, and 4-year CD. Second, divide that $4,000 into even allocations and open a CD as follows:
- Year 1: $1,000
- Year 2: $1,000
- Year 3: $1,000
- Year 4: $1,000
On Year 1’s maturity date, you then renew the $1,000 + interest earned into another 4 year CD. Rinse wash and repeat.
The benefit of this is that every year, you will have the ability to withdraw 25% of your money in the ladder if it’s needed. If you don’t need that money at the time, you will be able to re-invest the money in a long-term financial CD, which tends to have a higher percentage of return.
No, this will not rival return rates similar to the stock market over the long term. However, it’s about as safe of an investment vehicle as you can find at your disposal and a good strategy to be aware of.
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