Using Certificates of Deposit (CD) to Save Money
A certificate of deposit is an account set up at a bank for a set length of time. When you open a certificate of deposit (or CD) you are allowing the bank to use your money for a period of time. Your money is locked in with the bank. At the end of the set time period you can withdraw your money along with the interest earned. Typically the interest earned on a CD is higher than what you could earn in a regular savings account.
The benefits of a CD are that you earn a higher interest rate, you are prevented from spending your money (helpful for people who have a hard time saving), and you are forcing yourself to hang onto your savings. The drawbacks of a CD are that your money is locked away out of your reach for a length of time, and you are locked in with a set interest rate. If rates go up, there is nothing you can do about it. Technically you can pull your money out early but there are hefty penalties for doing so.
I think certificates of deposit are a great idea, but you need to be very careful when purchasing them. Please do not lock away all of your savings in to one CD for five years (yes you can get a 5-year CD). There are several ways you can purchase CDs to lower your risk and still allow you to earn more interest on your hard earned money.
One option is to purchase a number of CDs with different maturity dates. These are typically called CD ladders. Say you had $25,000 you were willing to put into CDs. You could open five CDs with $5000 in each all maturing in different years. You would purchase a one year CD, a two year CD, etc. The longer you are willing to lock your money away with the bank the higher the interest rate will be.
Another option is to take your emergency fund and disperse some of it into CDs. You could get twelve $1000 CDs, one for each month of the year. You would gradually be opening CDs and then one would mature each month. As long as you still keep some of your emergency fund in a truly liquid savings account I think this is a pretty good idea. If something sudden comes up, you will never have to wait more than a month for a CD to mature.
You could also purchase several certificates of deposit for varying amounts that all come due at the same time. Let's take that $25,000 example from above. Another way you could handle this is to open five $5000 CDs that all mature at the same time. This way if something comes up and you have to cash out a CD early you will only take a penalty on one $5000 CD, rather than on the whole $25,000.
I think certificates of deposit are a great way to save money safely AND earn a higher interest rate than the bank typically saves. If you haven't looked into CDs before, now is a great time to do so.
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