In every investment environment, investors look for low-risk investments with the highest interest rates. Rising interest in assets among people has been very noticeable (especially during these specific times of pandemic).
According to CNBC surveys, 45% of Americans participating in that survey are investors. The results show that the most popular type of investment is still the Individual stock market. However, cryptocurrency is quickly becoming a competitive investment. In this article, we will be discussing one particular type of investment – certificates of deposit.
What are ‘CDs’?
Certificates of deposit, or CDs for short, allow you to make a low-risk investment and know the actual amount of money earned in the end. It is a particular type of bank account similar to a traditional savings account, usually with a fixed interest rate. You put aside your money for a determined period of time and, in exchange, get guaranteed returns.
Unfortunately, the distinctive higher interest rate for certificates of deposit has decreased significantly since 2020. It is now questionable if CDs offer higher yields than a regular savings account.
We will try to determine if CDs are at the moment a smart investment strategy. By the end of this article, you will have the knowledge of:
- The advantages and drawbacks of CDs
- When the CDs are worth investing
- Profitable alternatives to Certificates of Deposit
So without further ado, let’s get into the details about CDs and if they are a good pick for savers.
The pros and cons of CDs
Like every investment strategy, Certificates of Deposit come with certain risks and benefits. We will explain the key advantages and drawbacks to help you decide if CDs are designed for your needs and financial goals.
Safety & Benefits
If purchased through a federally insured bank or financial institution, CDs can be a highly safe way to save money. That is because CDs are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). That means your personal finances will be safe even if the market crashes or falls into a bear market.
Unlike high-yield savings accounts, checking accounts, or deposit accounts, CDs have the locked-in rate of return. Neither banks nor credit unions can change it. However, new CD rates are being influenced by Federal Reserve. It can be both good and bad. Higher rates are dictated by the interest rates moves, but the low rates as well. Coronavirus pandemic severely impacted on investment environment and resulted in CD rates drastically dropping.
For instance, at the beginning of 2020, it was possible to find the best CD rates that were even higher than 2% Annual Percentage Yield for one-year or five-year terms. The same CD rates at the beginning of 2021 were 1% APY at most.
However, the major advantage of CDs is their stability – no movements of interest rates will cause your already invested CDs to lose their worth.
CDs are a good alternative for a short-term investment. Despite the fact that you lose access to your funds for a period of time, there is a variety of short-term CDs or longer-term ones. The maturity dates include six months, one year, and five years, making it simple to match your funds to your intended financial outcomes. Certificates of deposit are available with maturities as short as a week or as long as ten years, making them a versatile and appealing savings choice for many people.
Early withdrawal penalty
Losing access to your funds is only one side of the disadvantage coin. Withdrawing money from your CD account comes at a great cost. Many banks will charge you an early withdrawal penalty in the event of premature accessing the deposit. Usually, they take a certain set amount of interest, various for different CD terms.
For instance, these are the fees for early withdrawal determined by the top banks in the USA:
Bank of America
- For 1-month to 2-month CDs: All interest or 7 days of interest, whichever is greater
- For 3-month to 11-month CDs: 90 days of interest
- For 1-year to 59-month CDs: 180 days of interest
- For 5-year to 10-year CDs: 365 days of interest
- For 1-month to 5-month CDs: 90 days of interest
- For 6-month to 23-month CDs: 180 days of interest
- For 2-year to 10-year CDs: 365 days of interest
- For 3-month to 1-year CDs: 3 months of interest
- For 2-year CDs: 6 months of interest
- For CDs longer than 2 years: 1 year of interest
Bear in mind that the final deposit undergoes diminution due to taxes. When the maturity date is being reached and you cash out your invested money, the government takes a certain amount of money gained from interest rates and, therefore, reducing your earnings.
As mentioned before, CDs usually are offered with locked-in interest rates. It may appear to be an advantage – your invested assets will never lose their value. However, on the other hand, it will never gain more interest than the previously determined rate.
Are CDs worth it?
The Federal Reserve’s interest rate adjustments have an impact on CD rates. Since March 2020, the US central bank’s key rate has been set at zero percent to revive the economy amid the pandemic crisis, and CD rates have remained low.
While CDs are reliable and secure, you may not obtain the highest return on your investment. Furthermore, even with a high income, a CD investment is unlikely to outpace inflation. Therefore, it is not recommended to choose this investment strategy if you care about very high returns.
However, there are some situations when investing in CDs is still beneficial. If you have a certain amount of money you can put aside, it still may be a good choice. A lot of banks offer now no-penalty CDs so sometimes even the locked out money is not being an issue.
To successfully invest in CDs, you will have to get familiar with the concept of the CD ladder. According to Investopedia: ‘A CD ladder is a strategy in which an investor divides a sum of money into equal amounts and invests them in certificates of deposit (CDs) with different maturity dates. This strategy decreases both interest rate and reinvestment risks.’ For instance:
‘Let’s say you have $20,000 to invest and want to build a four-year CD ladder.
Step 1: Open separate CDs
Rather than putting all the funds in one CD, you put $5,000 in each of four CDs that will mature in one, two, three, and four years. You look to find banks with the best rates on CDs before investing the funds. What you start with is:
- $5,000 in a one-year CD
- $5,000 in a two-year CD
- $5,000 in a three-year CD
- $5,000 in a four-year CD
Step 2: Renew and convert each CD at maturity
As each CD matures, you renew it as a four-year CD. By doing so, after four years, you will have four four-year CDs, but only one of those CDs will mature annually.
If you had opened all of your CDs in January 2021, setting up the ladder would look like this:
- January 2022: renew the one-year CD into a four-year CD
- January 2023: renew the two-year CD into a four-year CD
- January 2024: renew the three-year CD into a four-year CD
- January 2025: renew the four-year CD into a four-year CD.’
Because one CD matures each year, you’ll be able to take advantage of the higher interest rates on the longer-term CDs while building the ladder. You can withdraw 25% of the funds from the ladder each year without penalty – In short, get a much better return.
If you found out that Certifications of Deposit are not the most suited type of investment strategy, we would like you to get familiar with a few other profitable alternatives.
Getting rid of high-interest debt
Consider paying off your credit card balance before you start putting your money into not always so profitable investments. Paid off debt may result in saving more money than actually investing while still owing money to the bank. Very often, interest rates on your credit card are much higher than of those low-risk investments and it may simply be not beneficial to invest and being in debt at the same time.
Companies that pay out regular dividends are known as dividend stocks. Dividend stocks are often well-established corporations that have a history of returning profits to shareholders.
Dividend-paying stocks can result in a much higher yield than CDs but also are riskier. Their worth varies depending on the swings of the market.
Be a lender
This investment strategy comes at significantly increased risk. However, according to Prosper, it is also equal to high returns. It is said that individual investors earn annual returns of 5.3 percent – and that is on average.
Based on their credit scores, you can lend money to borrowers in various risk categories. You get a higher interest rate for agreeing to lend to people with worse credit ratings. Basically, you would imitate the way bank loans work.
What are bond funds?
A bond fund, sometimes known as a debt fund, is a mutual fund that invests in bonds and other financial instruments. Stock and money funds are two types of mutual funds that can be contrasted with bond funds. Bond funds typically pay out dividends on a regular basis, which include interest payments on the fund’s underlying securities as well as periodic realized capital gains. It is also an excellent alternative to CDs. For example, Vanguard’s Short-Term Bond Index Fund has earned a 4.78 percent return just in the last year.
The Infinite Banking Concept
Infinite Banking allows you to imitate how a traditional bank operates and borrows money, but without the need to depend on a third party. You will be both a creditor and a lender.
Instead of borrowing from a bank, you borrow money against yourself and singlehandedly dictate cash flow while still allowing your whole life insurance policy to earn dividends (money) even though you are using that money elsewhere. In other words, you build wealth while borrowing and repaying the money held in the cash value of your permanent life insurance policy.
That being one of the most significant advantages of the whole life insurance policy, you will never have to deal with banking fees or interest rates on loans. As a policyholder, you can borrow money using your own policy’s cash value. Using this borrowing setup, you would never have to borrow money from a bank again and instead would borrow for yourself (your whole life insurance policy) and pay yourself back over time. Thus, being your own bank.
The goal of Infinite Banking is to duplicate the process as much as possible to build the value of your own bank. The duplication process happens by lending and repayment of money typically held in the cash value of a permanent life insurance policy.
Infinite Banking allows you to better work towards your individual and unique financial goals for yourself and your family and have control over your finances without dealing with banking fees or interest rates on loans.
Infinite Banking involves:
- Overfunding (with after-tax funds) a high cash value whole life insurance policy from a life insurance company
- Accumulation of Cash Value(tax-free) throughout the years you are a policyholder of your Whole Life insurance policy.
- Tax-Free Loans taken out against your whole life insurance policy’s cash value to use for your financial expenses.
By the process of borrowing for yourself, repaying, and so on – simply by being your own bank, you earn the financial freedom and control of your money.
Implementing this banking strategy into your life gives you much better control over your finances and helps you build wealth using the life insurance policy.
We hope that we have helped you determine if Certificates of Deposit is the right type of investment strategy for you. However, we wanted to make sure you have all of the resources to consider other methods.
You will never have complete control over your funds if you keep on using services provided by banks. Remember – the same way banks benefit from their fees, and interest rates on loans – you can too. Bank on yourself! Build wealth by mimicking the banking process of loaning and repaying.
You can learn more about the Infinite Banking concept and how to become your own banker by checking out our FREE masterclass!