Dear Financial Literacy Family,
Today’s topic: What is a CD or certificate of deposit? (Hint: It’s not just something used to play music.)
But, first I want to check with you. How are you doing? How are you feeling? I hope that you are doing well!
Now, let me tell you about a recent conversation that I had.
Once, my friend and I were sitting on my patio one morning. I had invited her over to share a brunch of bagels, smoked salmon, cream cheese, fruit, tea, and orange juice. After she told me about inheriting $5000, she informed me that she was not sure what she was going to do with the money. After a little more conversation, she informed me that she did not have any pressing bills that she needed to pay. So, she was thinking about treating herself with something.
So, we spent some time trying to figure out what she planned to buy.
After a few minutes, I realized that she had no specific idea of what she wanted. Instead, she was talking to other friends, and looking online, trying to find some ideas.
She mentioned that maybe she would just leave the money in her savings account. I asked her if she had an emergency fund set up, and she said that she had 3 months of her expenses saved. I asked if she had any other pressing things for which she needed to save. She said no. This is when I broached the idea of a CD.
First, let me explain why leaving money in a savings account is a bad idea.
When you put your money in a savings account, currently you do not make much money, because the interest rate paid is low. However, when your money is in the bank, your bank can make a ton of money off of your money. They make money by lending your money out at a high rate. For instance, they can lend it to people using the bank’s credit cards and charge something like 25% interest. However, they probably pay you less than one percent interest on your savings account.
Now…Back to the question…
What is a CD?
CD stands for certificate of deposit. A certificate of deposit is a saving instrument. They are offered by banks. Unlike a savings account, you cannot take your money out anytime that you want. Instead, you can deposit your money into a CD. With a CD, you agree to leave your money in the bank for a set amount of time. There are a variety of time periods in which you can purchase a CD. Some of the typical time periods for CDs are 3, 6, and 12 months. But, the periods can be even longer. Keep in mind when you pick a term, that you will have to pay a penalty if you withdraw the money before the CD matures.
What are the benefits of a Certificate of Deposit?
- You can earn higher interest rates than a savings account.
- They are safer than stocks and bonds.
- They have fixed interest rates.
- They have predictable returns.
- The money is insured by the FDIC, up to $250,000.
Where can I purchase a certificate of deposit (CD)?
If you are interested in getting a certificate of deposit, they can be purchased from banks. However, many brokerage firms, such as Fidelity Investments also sell CDs.
Now, do I think that you should invest some money into a Certificate of Deposit?
Many people will say that the interest is not high enough and those people might steer you in the direction of investing only in stocks. But, I disagree. I think that when you consider your entire portfolio, in addition to the riskier assets that have the possibility of earning you more money, you should have some less risky investments that likely won’t earn you as much money.
Why on earth would you want any investments that will bring you less money? Well, remember, with all investments, there is an element of risk. Some people will talk as if this is not the case. So, you want to have at least a portion of your funds that are in the least risky investments, but at the highest interest rate possible. Voila, that’s a CD. There is safety in terms of it being a bank deposit, while at the same time, you earn a higher interest rate in exchange for letting them hold onto your money.
What money should I put into CDs?
First, you need to understand the purposes of saving money. There are 3 reasons to save money. First, you should save for emergencies. At a minimum you should have 3 months of your expenses saved for emergencies. This money should be kept accessible. Having this emergency money will prevent you from having to go into debt if you were to lose your job. Second, you should save for short term goals. You should not go into debt for short term goals. Instead, you should save the cash to pay for these. Examples of short term goals include buying a new computer or taking a road trip. Third, you should save for long-term goals. Long term savings is money that you save to build the future that you plan. Examples of these goals are to buy real estate or build an investment account that will grow and pay you dividends.
The money that is best put into CDs would be part of your long term savings. If you have more than six months emergency savings, you could put the portion above 6 months into CD’s starting with 6 month CDs. In theory, these CD’s should mature at the time that your 6 months of cash would run out. which mature at a year or less.
So, There You Have It
By the time my friend and I had finished our brunch, she had decided that she would pursue investing into certificates of deposit. As you can see, there are better ways to save than putting your money into a traditional savings account in a local brick and mortar bank. To grow your money the fastest, you need to be strategic about how you save and invest it. Consider CDs as one of your strategic investment instruments.
Have a wonderful week, and keep working toward your goals. I believe in you!
Rich Mom
P.S. Have you ever invested in a CD? Do you have plans to buy one? Let me know in the comments.
P.P.S. If you received any value from this letter. I’d love for you to:
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I am not an investment advisor. The information that I share is not to be investing advice. It is meant to inspire. Always do your own due diligence and research before investing. Check with your own investment advisor.
Also remember that past performance is not a guarantee of future performance.
Thank You!