How to Invest in a Certificate of Deposit (CD)
With the general basic workings of a CD in mind, here are a few points to consider when determining how to invest in one.
Time HorizonThe first step in considering how to invest in a CD is choosing your term.
Yields and RatesAfter choosing the specific term of a CD, the next step will be finding the highest interest rates. To ensure the highest percentage returns, an investor will want to contact several financial institutions and get a list of rates for the term they have chosen. Some institutions will have the rates published on their website. The Annual Percentage Rate, or APR, is the rate typically quoted related to a CD and is the amount of interest that the CD would generate on an annual basis. Many longer term CD’s will also list the Annual Percentage Yield, or APY, which will indicate the yield on the CD when accounting for the compounding of interest. This is important to note when looking at CD’s with a 3,5 or 10 year term.
Types of CD'sThe most common Certificate of Deposit is a traditional CD which will give you a fixed rate for the life of the chosen term. In addition to the traditional CD, there are more complex CD’s offered with more complex terms or features. A common example of a non-traditional CD is one with floating interest rates, where the rate will change monthly or quarterly based on changes in an underlying base rate. Other non-traditional CD’s include those with favorable early withdraw terms (usually at a cost in terms of interest paid) or CD’s that offer the ability to swap interest rates or re-invest in a higher rate CD should interest rates change substantially.
Certificates of Deposit can be a useful addition to many investors’ portfolios as they provide a low-risk component, and depending on the terms structures, can provide regular cash infusions to a portfolio to either be reinvested in another CD or allocated elsewhere. They do offer lower returns than most bonds or mutual funds, so this does come at a cost.
By Jeffrey Glen
Posted in ...Investing