There are very many ways a consumer can invest their income in different financial products. One of them is via CD accounts. A Certificate of Deposit account is an investment instrument issued by most financial institutions that earn interest on a lump sum of money for a specified period of time. During this period, the saver is not allowed to withdraw the money or risks penalties and lost interest if they do.
Certificate of Deposit Account vs Fixed Deposit Account
A certificate of Deposit account differs from a Fixed Deposit account in a number of ways such as:
- CDs cannot be used as collateral for loans whereas FDs can be used to apply for a loan
- You can invest your money for a maximum of 12 months with a Certificate of Deposit account whereas Fixed Deposit accounts allow you to invest for periods of up to 10 years
- CDs have a higher minimum investment amount compared to FDs
Despite being less advantageous than a Fixed Deposit account, a Certificate of Deposit account has a higher interest rate. Therefore, if you’re willing to take a little risk, the reward is lucrative. Just like with most things, these kinds of accounts have their advantages and disadvantages which you should keep in mind before choosing this investment option. Here are some.
Pros:
1. Flexibility of Terms
With both long and short-term CD options, consumers can pick a strategy that best suits their financial situation. Yes, short CDs won’t be as lucrative as long-term ones, but they’ll likely give you more than what high-interest savings accounts would.
Besides the flexible terms, you use the Certificate of Deposit ladder strategy to take advantage of accrued interest over time. A set of Certificates of Deposits with varying term lengths is known as a ladder CD.
2. Predictability
Holding CD accounts also grants you income predictability. When you purchase a CD account, you’ll know exactly what the value of your account will be at the end of the term. Unlike the stock market, you won’t have to worry about market-based surprises. Furthermore, the interest the account accrues won’t decrease or increase as long as you leave the CD to mature.
3. Safety
One of the most attractive things about CD accounts is that they’re relatively safe.
What does that mean? It means that even if there are changes in the market, the matured CD account will retain the value you expected when you bought it. However, if you draw the funds before the account matures, you’ll have to pay a certain fee.
4. Better Returns Compared to Savings Accounts
Most standard savings accounts will yield you about 2% to 4% in interest. However, some of the top-quality Certificate of Deposit accounts provide interest rates of between 6.5% to 10%. In addition, most savings accounts don’t offer tiered interest rates, while CD interest rates typically increase the longer the term length. Why Failing To Invest Your Money Makes You Lose It
Cons:
1. Inflation
The inflation rate is typically not congruent with Certificate of Deposit Accounts, and in some scenarios, the inflation rate might grow quicker than the interest rate on CDs. Though this might not always be a cause for concern, it is one you should consider, especially when dealing with long-term CD accounts. 7 Ways To Survive Inflation
2. No Liquidity
Certificate of Deposit accounts is designed to entice you to keep your money in the account until the term ends. As such, you’ll typically have to deal with a penalty if you make a withdrawal before the account matures.
Since you can’t make withdrawals as you would with standard savings accounts, this kind of asset is not considered liquid as compared to a checking or savings account.
3. Low Returns
Though interest rates on Certificate of Deposit accounts are often higher than what you’ll get with regular savings accounts, they may not be as much as what you’d get with the higher-risk and more aggressive investments such as stocks and bonds.
For instance, a five-year, Ksh50,000 Certificate of Deposit account with a 3.50% interest rate will yield an interest rate of only around Ksh95,000 or so by the time the account matures.
If you want to invest some of your extra cash on something you won’t need to access immediately, then a Certificate of Deposit account is something you may want to strongly consider. As you can see they’re safer than high-risk investments like stocks and yield better interest than regular savings accounts.
Check out
Finance: What To Consider When Choosing A Long Term Savings Account
Five Ways To Save For Your Retirement Without Straining Your Pocket
