Certificates of deposit (CDs) are a great option for those looking to grow their money over time while assuming little to no risk. Getting the most out of your savings is a key element of financial literacy, and understanding the benefits and drawbacks of CDs can help you achieve your savings goals.
CDs offer a way to earn interest on your money by depositing it with a bank, credit union or similar financial institution. These accounts are usually covered by the Federal Deposit Insurance Corporation (FDIC), so they are considered extremely safe investments. Many people use CDs to help offset the effects of inflation on their savings.
Is There a Way To Add to Your CD Balance?
In general, CDs do not allow you to add to your balance. Once you make an initial deposit, the CD’s balance is locked in to keep earning interest until its maturity date.
This is part of the reason that CDs usually offer higher interest rates than other types of deposit accounts. When investing in a CD, you’re committing to locking your money away for a set amount of time. You can’t add to the balance — and there are often steep penalties for withdrawing your money early. In exchange for less liquidity, you’ll get a greater return on your deposit.
Other Options for CD Savings
If you want the low risk and greater return of CDs with a bit more flexibility, there are two ways to use CDs that allow you to contribute more money over time: purchasing an add-on CD or using the CD laddering strategy.
An add-on CD differs from a traditional CD in that it allows the depositor to contribute additional funds to the account during its term. The terms of this type of CD will differ depending on which institution you’re purchasing from. For example, some may have a maximum value that the CD can have, while others may only allow you to make a certain number of deposits over the term.
To get the most benefit out of an add-on CD, choose one with a longer maturity date — one of at least two or three years. It’s also advisable to opt for a CD with no maximum value or limit on the number of deposits you can make. As with any CD, always shop around to find one that offers a competitive interest rate compared to other add-on CDs on the market.
Another option is to use a CD laddering strategy. With this strategy, you purchase multiple CDs, each with a different term. For example, one with a six-month term, another with a one-year term and a final with a two-year term. By diversifying your deposits, you can take advantage of the minimal commitment associated with short-term CDs and the higher interest rates offered by CDs with longer terms.
As the CDs in your ladder mature, you can liquidate the accounts and bank the principal and the interest. Or, you can keep adding rungs to the ladder by renewing the CDs for another term to earn even more interest.
Options for Saving Beyond CDs
There are other ways to build savings with greater flexibility than offered by CDs. Depositing money into a savings account or investing it in an IRA can both help you save money and work towards achieving financial wellness.
Savings accounts usually have higher interest rates than your typical checking accounts, but they are not usually as high as CD rates. You won’t earn as much interest on your money with a savings account as you would with a CD, but you’ll have the freedom to withdraw your money on your terms without penalties.
The FDIC insures savings accounts, so they are a great option for people who want the security of a CD without sacrificing liquidity. You can also opt to open a high-yield savings account offering an even more competitive interest rate, though there may be restrictions such as limited monthly withdrawals.
If you’re thinking about saving for retirement, opening an individual retirement account (IRA) might be a more suitable solution than a traditional CD. Like CDs, you’ll face a steep penalty for withdrawing money from an IRA too early. You won’t be able to access the money in your IRA without paying a penalty until you turn 59 ½. But over the long term, IRAs generally provide a greater return on investment than CDs since they are tied to the growth of the stock market.
Because the maturity period on an IRA is so long, you can contribute to it throughout your lifetime. The federal government caps IRA contributions at $6,000 annually, or $7,000 if you’re 50 years old or older. You contribute money to the retirement account and then use that money to purchase shares of investment products such as stocks and mutual funds.
Given that an IRA is based on the health of the stock market, there is also more inherent risk involved in this type of investment vehicle. The funds in an IRA are invested in securities and are not backed by FDIC insurance. Because of this, you risk losses if the value of your IRA portfolio goes down.