Certificates of Deposit

Certificates of deposit are financial instruments issued by a financial institution for a specific dollar amount and period. They can range from $500 to $5,000 or more, though the most depositors tend to limit them to $5,000 and invest larger amounts into a money market account that pays higher interest and is has more liquidity than Certificates of Deposit. On the other hand, Certificates of Deposit must remain on deposit for the specific amount of time that you designate when you purchase the CD, or you will pay a penalty in addition to losing the higher interest rate that a CD normally pays.

Unlike statement savings accounts or money market accounts, you purchase Certificates of Deposit in pre-determined denominations such as $500, $1,000, $5,000, and so on as specified by the financial institution. If you are looking for a higher interest rate for your savings but want something that you can access quickly and without a problem, a Certificate of Deposit is not the right account for you. While long term Certificates of Deposit offer a better interest rate in many cases, a short term Certificate of Deposit may only tie up your funds for a six month period. For customers who have funds that they wish to keep on deposit for the entire length of the requirement, these type of accounts work quite well. Consider the length of time associated with a particular Certificate of Deposit before you invest your funds. However, if you are the type of person who needs frequent access to your funds, you will pay more in penalties than the extra interest you will earn using CDs instead of a statement savings account. Money market account holders are allowed to make three withdrawals per month with no penalty as long as the balance remains within the minimum limitations, which works much better for those who have a tendency to need to make regular withdrawals.

Banks offer several different types of savings accounts from which you can choose, but a Certificate of Deposit usually has the highest interest rate. To define a Certificate of Deposit simplistically, one can say it is a monetary instrument with a set monetary amount for a specified number of months. The interest rate on a Certificate of Deposit is contingent upon the term of the CD, with the interest rate becoming higher the longer the term of the CD. What this means is that a $500 Certificate of Deposit yields a lower interest rate than a one-year Certificate of Deposit. Unlike savings account, you purchase a CD in a set amount such as $500, $1,000, $5,000, and so on, and if the need arises to make a withdrawal, you must cash out the entire CD; you cannot simply withdraw the portion you need as you can with a savings account or money market account.

Only certain types of depositors fit the requirement for a Certificate of Deposit, and that type is those who have the financial ability or funding to purchase the CD and leave it on deposit until it matures. Only by leaving the Certificate of Deposit untouched for its entire term can you expect to gain any of its benefits. If you are unable to allow the CD to mature before cashing it in, you are much better off with statement savings. Even a money market account is intended for those who rarely touch the funds since few withdrawals means less potential for the account to go below the minimum balance requirement. It is important for you to answer that question before you open the account in order to determine if a Certificate of Deposit is the right type of account for your needs. While a Certificate of Deposit is a great savings option, it does require that you have the funds to leave your money untouched for a set period of time.

For the majority of people, purchasing a Certificate of Deposit means converting statement savings funds into a higher interest bearing account. Quite often, the typical process is to take some of the funds in the savings account and use it to purchase a Certificate of Deposit, leaving some funds in the statement savings in case they are needed for something else. This makes good sense since leaving nothing in the statement savings means having to cash in the Certificate of Deposit if the cash is needed, thus paying a penalty for early withdrawal.

Even if you are a high deposit customer, putting all of your money into CDs is not a wise decision to make. If you don’t want to utilize statement savings, you can take advantage of a money market account, which still allows limited access to your money without the penalties imposed upon early withdrawals of Certificates of Deposit. Money market accounts also often higher returns in many cases. For those who are not as fortunate and have only minimal cash in statement savings, the wise thing is to wait until you have more enough in the savings account to purchase a Certificate of Deposit and still have money remaining in the statement savings account. You never want to tie up all of your savings in CDs because of the possibility that you may need some of the money. It is less expensive to keep some cash in statement savings that to perhaps forfeit the higher interest rate and pay a penalty if you have to withdraw the funds that you have invested in Certificates of Deposit. A typical rule of thumb is to have at least two months’ salary in a savings account, so if you want to tie up your savings into CDs for the higher interest, make sure you still have enough easily accessible funds in a savings account to carry you for that two-month recommendation.

It may sound like a difficult choice, but in reality, the choice is simply a personal one that is based upon your particular lifestyle. This is important because of the penalties involved with Certificates of Deposit for early withdrawal. Money market accounts do not have a penalty for early withdrawal, and in fact, allow for three withdrawals within a month. The only problem may occur if your withdrawals reduced the balance below the minimum allowable for the interest rate you are earning. In that case, the bank would pay the interest rate for the money you have on deposit. Of course, the downside of that is that if the amount on deposit should fall below the minimum for a money market account, your account would be reduced to a statement savings account. Money market accounts typically require a larger initial deposit and larger minimum balance than a Certificate of Deposit.

The disadvantages of a Certificate of Deposit certainly do not outweigh the advantages by any means. For those depositors who are able to purchase the CDs and hold them until maturity, it is certainly the most profitable type of savings account, but for those who need a more flexible account or who make frequent withdrawals, you need to think of a different account. The penalty the bank imposes on early withdrawals undermines any additional interest the bank pays on a Certificate of Deposit. Unlike a savings account, you cannot make a withdrawal of a portion of the CD, you must cash out the CD, and any amounts you don’t need, you can redeposit into the appropriate savings account. The penalties are imposed as a deterrent, to discourage customers from cashing in their Certificates of Deposit before the maturity date.

When you are ready to purchase a Certificate of Deposit, it’s important to remember that all financial institutions do not offer the same rates, terms, or have the same minimum deposit requirements. Some banks offer CDs as low as $500 while others start at $1,000. Terms as low as six-months are the norm, but it is not unusual to find terms as low as three months, or even thirty days, normally called jumbo CDs because they not only have a lower interest rate and shorter term, but they tend to have a much larger balance requirement, sometimes as high as $90,000-$100,000 in some cases. These particular Certificates of Deposit are intended for the high-end investor who wants to yield the highest rate of interest in the shortest amount of time.

When you choose a Certificate of Deposit, you have to choose the one that is right for your individual needs, and if it means taking one that has a lower interest rate, then that is what is necessary. Don’t immediately assume that you have to deposit money with the bank where you have your checking account, your mortgage, or your car loan because they may not be the banks who will offer you the best rate on a CD. If you want your CD to make the most money for you, it’s pertinent that you research thoroughly the different types of CDs and their associated interest rates before you purchase one. Take the time to shop around at banks both in person and online to find the best rates and terms for your Certificate of Deposit. Like anything else in life, waiting a little longer to find the best deal makes economic sense. It is never financially sound to purchase the first CD that “appears” to have a higher rate than the others do in your area. Take the time to investigate as many financial institutions as you can before you make a decision.

If you’re new to the market of Certificates of Deposit, you may ask whether it’s better to purchase CDs in smaller amounts for a shorter time or wait until you have the larger funds to do that. There is no easy answer nor is there just one answer to that question. The only answer that really makes sense is to tell you that you have to do what are best for your individual situation. If it’s easier for you to purchase Certificates of Deposits in denominations of $500 for six months in order to reap the most benefit from it, then that’s perfectly acceptable. You don’t have to wait until you have $1,000 or more and purchase something in a larger denomination, thinking you will make more off it. Depending on the rate you get on the CD, it’s possible you will yield more by purchasing $500 CDs for six months at different intervals than waiting to purchase something larger while your funds lie dormant in a low-interest statement savings account in the meantime.

One of the problems that are apparent when you try to wait for more funds to purchase a CD is that while you are building up the funds, you may have a tendency to spend the money that is so readily accessible in a statement savings account. If you take the funds as you has them and convert them into $500 Certificates of Deposit, there is less chance that you will withdraw the money and possibly never put it back. Of course, you want to make sure you keep some money in the savings account to avoid the potential for having to cash in the Certificate of Deposit; however, with a short term CD, there is less of that opportunity than with a longer term CD. Certificates of Deposit should only be one part of your overall savings plan, with some funds available, some in short term investments, and some in longer term investments.

When it comes to your money and letting it work for you in the best way possible, one cannot always play favorites with the financial institutions. At different times, a bank may have different rates, so you must be cognizant of that. Even if you have dealt with your bank for many years, do not discount the potential possibility that another bank has a better rate on CDs or can offer you a smaller denomination at a more favorable rate than your regular bank. It is a competitive business, and you need to be willing to search the market in order to secure the best interest rates that are available. That may mean, “Spreading the wealth around” as the saying goes, meaning that you do not have all of your CDs in one bank, but you research and locate the one that has the best rate at the time you are ready to purchase a Certificate of Deposit. It’s important to keep in mind that these rates change frequently, often during the course of a day, so the rate you got last month may not even be the same today, and the bank down the street may have a more favorable rate when you’re ready to purchase a CD. You don’t want to make the mistake of assuming that the rate you have on one CD is going to be the same for another one nor do you want to make the mistake of assuming that every bank pays about the same rate. Only by doing some research each time you buy a CD will you know that you are receiving, the best rate the banks offer at that time.

In order to know that you have the best rate on a Certificate of Deposit, it’s important to keep a close watch on the market and know what is going on in your general vicinity. The changing market is the reason that it’s important to keep an eye on the trends as they relate to different types of financial instruments including Certificates of Deposits, and by choosing a short-term investment, there is less a chance of losing a higher rate because you are locked into a rate for a year or more. Keep your eyes open and your options flexible so that you know when to move your money and where to move it. Even a statement savings account has a tendency to move with the trends so don’t allow yourself to become so comfortable with one bank that you hesitate to consider moving your money to a different bank. After all, if your bank started charging a higher service charge on your checking account than other banks are charging, you would certainly move your money elsewhere; that is the same line of thinking you should invoke for your savings accounts.

Is it feasible to have CDs in several different banks? The best answer to that is to ask another question: Why wouldn’t it be? It isn’t as though you have to go in every week or two to make a deposit, and thus have to visit more than one bank. Certificates of Deposit are low maintenance investments, so select the bank with the best terms and rates for your needs. If that were the case, it may perhaps be a bit inconvenient to have your savings in more than one bank. However, since CDs are not the kind of instruments that you move money in and out of, there is no reason to keep it in the same bank. In fact, having the money in several different banks may create less of a temptation for you to withdraw the funds early and therefore save you penalties for early withdrawal.

Certificates of Deposit are not as flexible as a statement savings account and should not be treated as if they were. The funds in a CD are designed to be kept on deposit for a specified period, and failure to do so results in penalties for early withdrawal, thus foregoing the purpose of purchasing a CD in the first place. It’s important to be cognizant of the changing trends in the financial market and know what other financial institutions are paying in interest on CDs so that you can get the best rate that is possible.

Don’t feel that you have to keep all of your money in one bank, or even purchase all of your CDs the same place. It is a competitive market, and you should always allow yourself the freedom to look for competitive rates. Knowing that you are not bound to one bank sometimes creates a feeling of competition that may tend to press the bank into offering a better rate in order to keep your business, but you should not look for that to happen, but do what you need to do to make your money work for you.