What is a CD?
Here’s an excerpt from Wikipedia:
A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions.
CDs are similar to savings accounts in that they are insured and thus virtually risk-free; they are “money in the bank” (CDs are insured by the FDIC for banks or by the NCUA for credit unions). They are different from savings accounts in that the CD has a specific, fixed term (often three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest.
So if you are investing/buying a CD you want to make sure you don’t need that money for the length of it’s term (otherwise you will have to pay a penalty to cash it in).
Here’s a great way a beginning saver can get started with CD’s:
- Figure out a monthly amount of money you know you won’t need for 12 months. Don’t be scared now. It can be a small amount like $10.
- Log into your ING account and go to their products page. Click on CD’s and proceed to open up a $10 CD for a 12-month term. (If you can afford more by all means do so. Remember this is money you won’t touch for a year.)
- Now every month do the same thing for a total of 12 months.
- At the end of a year you will have 12 CDs worth more than $120 (imagine if you put more in each month?). If you can, re-invest the CDs as they mature. See if you can add to the amounts, again even if it’s only a few dollars.
“What have we done? Anyone can buy CDs!”, you may ask? Remember this is for a beginner who is starting to build up their savings. Here is what the beginning saver has accomplished:
- This builds up a habit of saving. By putting the money in a CD we’re limiting the ability to take the money out (without a penalty at least). Once this habit is in place a beginning saver may have the discipline to expand their savings.
- It creates a great sense of self-esteem for the saver. You get to see your CDs growing every month. How great is it to see a year’s worth of savings? Once a person realizes that saving is an achievable goal they will be more likely to continue!
- You’re earning interest. Not only have you saved but you’re savings are growing too! You’re taking advantage of laddering.
Savings aren’t usually built overnight. But by saving bit by bit you will see your savings blossom over time!
photo credit: naama
I’ve been wanting to open a CD for quite some time, but I’m not sure how the interest rates compound. Can you explain this, too?
You left out the best part- you’re dollar cost averaging the interest on those CDs! In other words, you’re not trying to guess the best time to buy CD’s, trying to get the highest rate of return. Ladders allow the investor to follow a disciplined approach to diversifying the interest rate; if the rate is going up, then you’re locking in a higher return and if the rate is going down, you’ve already locked in the previous higher return with last month’s CD (in your example).
CD’s are perfect for long term emergency savings. Let’s face it – that money should be used in case you lode your job or some other “nightmare scenario” where the interest penalty is negligible compared to the loss of income.
I tend to disagree and not focus on investments like CDs. The rate of return on a new CD these days hardly beats inflation, and your money is locked up. If you have zero investing knowledge and tend to rack up debt, then sure a CD may be a good option. If you are willing to do minimal research, there are plenty of better options. I’d recommend an index fund over a CD, especially for young people. In fact, people near retirement are probably the only ones who should use CDs since they are just looking to preserve capital.
I’m curious – would you recommend an index fund for, say, emergency savings?
I wouldn’t use equities of any kind for an emergency fund. In fact, my own efund is half in CDs because the point of my efund is to have money that I won’t be tempted to spend, but can still get to easily. (I’ll forgo the interest if I need faster access.)
My ladder is for six month with each ‘rung’ being one month’s expenses + COBRA. This is money for the ‘catastrophic job loss’. There’s also a plain jane ING savings account for the ‘roof leaks, car explodes’ types of emergencies.
i was interested in opening up a CD with ING DIRECT but the link for the $25 bonus is expired. Is there a way that you csn help me out with this? I’d greatly appreciate it.