Invest in CDs

One way to have more of the benefits of compounding interest while maintaining a low-volatility investment is to invest in certificates of deposit.  A certificate of deposit, commonly abbreviated as CD, is similar to a savings account, but not exactly the same.

When you invest in CDs, you are loaning money to the bank, just as with a savings account.  As such, the bank pays you interest.

The main feature that differentiates a CD from a regular savings account is that a CDs have terms.  The term of a CD indicates how long you’re willing to let the bank keep your money.  If you need the money back before the term is completed, you can get it, but it will cost you an early withdrawal penalty.  This might be six months of interest.

It’s for this reason that the rates offered on CDs are usually higher than for a typical savings account.  Also, the longer the term, the higher the rates offered, since you’re investing your money for longer.

Different banks offer different term lengths — some as short as 1 month and others as long as ten years.

To summarize:

  • Pros of CDs.  CDs typically pay higher rates than a savings account, and many pay more than a Series EE Savings Bond. In addition to the higher rates, there is a wide range of terms to accommodate whatever it is you are saving for. They are also insured by the FDIC, which makes them very safe.  The rate is steady, with (usually) no fluctuation; it’s a return you can count on.
  • Cons of CDs.  CDs aren’t quite as liquid as a savings account, due to the early withdrawal penalty.  The return, though steady, is capped, so you can possibly earn a higher return elsewhere.  Sometimes to get the higher rates of return you’ll need to make a substantial deposit, with some as high as $25,000.

In addition, a CD will tie up your money for the term of the CD. And because the rates on a CD are fixed, you could be locking in a low interest rate if you buy when the rates are down. If you withdraw your money before the maturity date, you will be charged a tight penalty.

Most banks offer CDs, but there is a wide range in interest rates and maturity lengths. Be sure to shop around for the best CD rates before buying, and feel free to purchase them from multiple banks as rates change.  Competition is your friend.

So, if you’ve got some cash you don’t need for a while that you want to invest, but aren’t confident of the rate of return for other investments, a certificate of deposit will usually beat a savings account.