Avid investors often use Certificates of Deposits (CDs) as an investment vehicle. CDs are common bank and credit union options which will offer stable income based on defined interest rates. This article may help you determine if investment in a certificate of deposit makes sound financial sense. As with all investments risk and reward need to be carefully evaluated and it is suggested that each investor do their own due diligence.
Terms of a certificate of deposit.
As mentioned, CDs are always based on interest rates and the certificate is set for a defined term. Common term lengths include: three months, six months, 12 months, 24 months, 36 months, etc. Generally the longer the term the higher the interest rate and potential earnings. One caveat however, is that early withdrawal of certificates of deposit is often penalized by a fee or loss of interest earnings.
A quick look at the numbers.
It is essential that you evaluate the term length first. Do not consider rates at this time. Decide how long you are willing to let your money sit in the CD. Make sure it is money that will not need to be used for other expenses or investments during that term. Let’s look at an example. Say you have $1,000 for investment and that you are sure you will not use that $1,000 for at least one year but possibly as many as three years. Fictional interest rates for CDs are as follows:
3-5 months, 0.15 percent
6-11 months, 0.25 percent
12-23 months, 0.45 percent
24-29 months, 0.50 percent
30-35 months, 0.60 percent
36-47 months, 0.80 percent
48-59 months, 1.15 percent
60 months, 1.85 percent
Let’s run the numbers. Multiply the yearly interest rate by the principle amount ($1000 in our example) and multiply the result by the number of years the CD is actually open. Example: 12 months at 0.45 percent with $1,000 dollars will yield:
$1,000*0.0045*1 = $4.50 after 1 year.
If you chose a 48 month CD the numbers would run as follows:
$1,000*0.0115*4 = $46.00 after 4 years.
If you chose a 3 month CD the numbers would run as follows:
$1,000*0.0015*0.25 = $0.38 after 3 months.
In these examples the net gain is quite low, but there is absolutely no risk involved as long as the CD is not withdrawn early. CDs can offer stable investment options, but it is essential to evaluate the numbers. CDs only make sense if that money could not be used in a more efficient manner.