When is investing in CDs a good choice?
Posted in: Banking
Certificates of deposit (CDs) are great vehicles for investors who want a short-term, fixed investment.
Why short-term? Because CD rates are based on current interest rates when they’re purchased; CDs continue to pay that fixed rate even after outside interest rates have risen.
CD rates are not competitive with the fixed rates found in long-term investments like corporate bonds, nor do they offer the tax advantages of some municipal bonds (unless the CDs are purchased within an IRA). They also lack the long-term potential of variable products and stocks.
To understand the interest rate lock-in, let’s say you find a CD with a 1.3% interest rate for a six-month term and a 3% interest rate for a five-year term.
You may think that means it’s best to get the 3%, five-year CD, but if interest rates go up in two years and CDs are offering more attractive rates, you’ll still be locked into your old 3% rate for another three years.
And since CDs charge you a penalty for taking your funds out before maturity, it’s often not in your best interest to do so. This makes committing to a long-term CD in a low-interest environment a potentially risky investment decision.
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