Pros and Cons of CD Accounts
Your CD player may be great and all, but what we are talking about here is not the pros and cons of compact disks. Our main topic covers certificate of deposits, or CDs as finance people call them.
A CD is a type of savings account generating interest income and bearing a maturity date, say, three months or one year. For example, if you hold $100,000 in a CD bearing a 5% annual rate, you will earn interest of $5,000 at the end of 365 days.
A CD is insured by the Federal Deposit Insurance Company (FDIC) and generally is issued by a commercial bank. The product has advantages and disadvantages, ranging from fixed maturity and early-withdrawal penalties to FDIC insurance.
You can purchase a CD through a brokerage firm, and some institutions may allow you to cash in the CD before the maturity date without incurring penalties.You can open a CD account as easily as you would open a regular checking account. Just walk into a commercial bank's branch and ask to purchase a CD. You can transfer money from your checking or savings account into the CD, but make sure the bank is FDIC insured.
A CD is a risk-free investment that is insured by the FDIC as long as your account value does not exceed $250,000. Note that if you own several accounts at the same bank, you're only insured up to $250,000 because the FDIC insures deposits at the individual level, not at the account level. With a steady flow of income from a CD, you can have peace of mind and can move on with long-term financial planning. CD account rates generally give a higher rate of return than what you earn investing in similar risk-free instruments like U.S.
Treasury bills and savings accounts. Your rate of return on a CD is fixed and does not fluctuate in accordance with the vagaries of the economy and the ups and downs of financial markets.
You have to leave your money in an account for a relatively long time that can top five years, and some institutions may charge early-withdrawal fees if you need the cash before the CD's maturity date. The CD's rate is locked, so if the market average rate goes up, you could be losing money. For example, if you have $10,000 tied in a CD for five years at 3% interest rate and if the market rate increases to 7%, you would be leaving 4%, or $400, on the table every year.
The limit for FDIC insurance is $250,000 per bank, so if you want to invest more than that amount, you would need to open an account at another bank. For example, if you want to invest $1 million in a CD, you would need to open four CD accounts at four different banks.The CD rate is secured, and that makes it carry a lower interest rate than you would get by investing in other money market instruments.
A certificate of deposit is a risk-free investment account that the FDIC insures up to $250,000 per account holder per bank. The account has pros that include fixed rate and federal insurance, and cons that run the gamut from early-withdrawal fees to FDIC insurance thresholds.