Why Do You Need an Emergency Fund?
- Job loss or unemployment
- Medical or dental bills
- Home repairs
If you want your money to work a little harder but aren’t so sure about investing in stocks or bonds, look into a certificate of deposit (CD). With a CD, you can earn peace of mind (oh, and savings) if you’re able to lock in your CD rate for a fixed term. Since it’s easy to estimate your earnings, a certificate of deposit could be just what you’re looking for to help you manage and plan for your future.
Some people use the earnings from a CD to supplement their Social Security and retirement income later in life. Others use a series of CDs, called a CD ladder, to store an emergency fund to earn more interest than they could with a checking or savings account.
So, how to open a certificate of deposit? The process can be similar to opening a checking or savings account. However, there are more moving parts to keep in mind. If you’re considering opening a certificate of deposit, consider these six steps:
After learning how to open a certificate of deposit, you may want to review the different types of CDs to see which one best fits your financial goals. Hint: Take a look at the factors that can impact a CD’s interest rate.
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A traditional CD has a fixed term and interest rate, but that doesn’t have to be the case. For example, you may be able to open a variable-rate CD, and its interest rate could go up or down over time. Other types of CDs include:
There are also some common features that could vary depending on the issuer and type of CD. Here are a few to consider when you open a certificate of deposit that may affect your earnings or expenses:
While CDs can be a relatively safe way to grow your savings, there are some risks when you open a certificate of deposit. Liquidity risk—the risk that you’ll need the money when it’s locked up in a CD—is an important one.
Ngo doesn’t recommend opening a certificate of deposit if you think you’ll need the funds in less than a year. You can always consider putting short-term funds in an online savings account, where you can earn interest and ditch the concern about liquidity.
However, Ngo adds that as long as you have an emergency fund, “if you will not need the cash for two to five years, a CD is a great option if you are afraid to invest it in the market or in bonds.”
There’s also a risk that interest rates rise in the future. If that happens, your money could be locked in a CD and earning you less interest than you’d get from a savings account.
Building a CD ladder could help you minimize liquidity and interest rate risk. That means rather than buying a single CD with $10,000, you could buy four $2,500 CDs with one-, two-, three- and four-year terms. Each year, one of your CDs will mature. If you need the money, you’ll be able to take it out of your ladder without paying a penalty. Alternatively, you can reinvest the funds in a new four-year CD and get an interest rate that’s higher than what you’ll find on a one-year CD.
While there are some risks involved with any investment, opening a certificate of deposit can be a safe way to grow your savings. “If the money to be invested is needed within a certain time frame, a CD can fit your schedule,” Niggel says. He calls them a “low-risk and low-expense savings tool. ”
Whether you’re building your savings for a short-term goal or looking to increase your fixed income, now that you know how to open a certificate of deposit, you can add this financial tool to your repertoire of options.
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1 Study by T. Rowe Price Retirement Plan Services.