ABCs of CDs

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You probably haven’t had to think about CDs since the first gen iPod came out, right? No—we’re not talking about those CDs; today, we’re talking about Certificates of Deposit.

Certificates of Deposit are an investment vehicle where you lock your money for a certain period of time; maybe, three, six, nine months or even up to ten years. You pinky swear not to touch that money at all, and in exchange, you get a slightly better return than other savings vehicles when you go to take it out. And the longer you leave your money in a CD, the more interest you will get.

And if you break that pinky promise, or, if you take money out earlier than the maturity date, you’ll have to face a penalty. Many CDs will charge a penalty of six months’ interest if you take your money out early. So, while these are great ways to make some extra money, you need to be able to handle an emergency without solely relying on those funds. There are “liquid” or “no-penalty” CDs out there that will not penalize you for early withdrawal, but they also come with a lower rate of return. While CDs are typically considered pretty straightforward investments, there are three interesting flavors to consider:

1. Market-Linked CDs. This type of CD tracks the market, so you don’t have fixed rates of return. If the market goes up, you could make more than you would with a conventional CD—but if the market goes down, you won’t.

Market-linked CDs have longer terms (think years instead of months) and even higher penalties if you take the money out early; meaning that once you stash your cash in there, it’s going be tied up for a while. They are also taxed at higher rates than regular CDs. Plus, you have to declare interest each year of the term, not at maturity, so you may be paying tax before you even make money from them. Still, if you want some market exposure without the risk of losing your initial investment, market-linked CDs might be a good option for you.

2. Brokered CD. These are offered by some broker-middleman (or middlewoman) who buys CDs in bulk for sweet rates and then sells them to institutions and individual investors. These can be bought or sold on a secondary market before their maturity date, but the rules are much more complicated, so if you want to go this route definitely discuss it with a financial advisor first.

3. Jumbo CDs. These require at least $100,000 as an initial deposit but offer a higher rate of return. Dream big, folks!

One word of caution

Some CDs go into auto renewal mode, automatically signing you up for another CD when the first term is over. Luckily, you already know the best way to avoid that pitfall: that is, set a calendar reminder for the day before your CD term ends to either withdraw your money or re-up the term... on your terms.

How do I feel about CDs? Well, just like I wouldn’t put 100 percent of your emergency fund in a high-yield savings account, I wouldn’t put all of it in CDs either. But they are a good option for keeping your principal safe while getting some additional bang for your buck.

xo,

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