Hey there! Today we’re going to talk about what CDs are and why you might want them as you save more money for the future. There are many advantages of CDs, including the safest way to earn passive income, which for risk-averse folks might be the answer they’ve been looking for.
What does CD stand for in banking?
You may have guessed by the title of this post that a CD in banking stands for a certificate of deposit. As you might imagine, it’s much easier to say “CD” versus “certificate of deposit” in everyday conversation, and it’s also easier to type.
What is a CD?
A certificate of deposit is offered by banks to its customers, where the customer agrees to leave a specified amount of money tied up with the bank for a specified duration. In return, the bank will pay the customer interest on their money. Generally, longer-term CDs pay more than shorter-term ones.
More than likely, your CD will have a guaranteed rate of return. This can be handy over a high-yield savings account where your rate may go up and down with market conditions.
CDs are different than traditional savings accounts in that with a savings account, you can deposit and withdraw money somewhat frequently. But, with a CD, you will face early withdrawal penalties if you withdraw your money before the maturity date. The exception to this is if you have a no-penalty CD, which I’ll go over below.
One advantage of CDs that you might consider is using them as a way to earn passive income. By forcing yourself to lock in your money, you won’t be tempted to withdraw your principal, but you’ll also earn interest every month.
What is a no-penalty CD?
A no-penalty CD is a type of certificate of deposit where you will not be penalized if you withdraw your money early. That said, each financial institution may have different rules about how their no-penalty CDs work. Some may require you to leave the money untouched for a minimum specified period before you can withdraw without penalty.
A no-penalty CD might be more attractive when rates are fluctuating because you can withdraw from them and open a new CD with a higher rate should rates increase.
How do CDs work?
A certificate of deposit has a fixed term and generally a fixed rate. Other properties include:
- There may be a minimum deposit.
- A higher deposit amount might mean a higher interest rate earned.
- You can’t withdraw money early without penalty unless you have a no-penalty CD.
- You cannot add more money to your CD after you open it. You can, however, open more CDs.
With a CD account, you are agreeing to leave a deposit in your account for a specified amount of time. You can’t withdraw the funds early without taking a penalty. The bank agrees to pay you a fixed interest rate, which is typically higher than the average savings account. Generally, the longer the term of the CD, the higher the interest rate.
Related Post: Maximize Your Savings With This Savings Account Guide
CDs come in varying terms such as 6-month, 12-month, 2-year, 3-year, and so on. CDs earn compound interest, meaning that the interest that you earn earns interest on itself.
Are CDs safe?
Certificates of deposit are considered by analysts as the safest form of investment. Similar to savings accounts, CD opened at most banks are FDIC-insured up to $250,000 per person. FDIC stands for “Federal Deposit Insurance Corporation.”
If something were to happen to the bank that holds your money, you would be able to get your money back, up to $250,000. This makes CDs incredibly safe.
You can open a CIT Bank certificate of deposit with this link and begin earning passive income today!
Are CDs worth it?
You bet they are. Certificates of deposit are a safe and secure way to earn interest on your money. If you know you won’t need your money for some time, and are looking for a safe investment for passive income, CDs are the way to go.
Do note that CDs don’t generally keep up with inflation. In the long run, you’re losing money compared to if you were investing in the stock market. That said, having money in a CD is a much better alternative than having money in a traditional brick-and-mortar savings account, where you’d earn around 0.09% APY.
You can also build a CD ladder, which I’ll go into just below.
Building a CD ladder
You might want to build a CD ladder to consistently get returns on your money each year. This is a great form of effortless passive income.
To build a CD ladder, let’s say you have $5,000. You would open a CD with $1,000 in each of a 1-year, 2-year, 3-year, 4-year, and 5-year CD account. When the 1-year CD matures, you would get back your $1,000 and keep your interest that had been building all year.
You would then reinvest your money into a 5-year CD (remember, your original 5-year CD would mature in 4 years now since a year has passed). Each year, you would reinvest your maturing CD into a new 5-year CD.
You can keep the interest you earn each year, or you could further invest the interest to continually and safely grow your money.
Creating Passive Income With CDs
For those that are risk-averse, you can earn guaranteed passive income with CDs without putting your capital at risk. This a big advantage of CDs. As standard CD rates are fixed for their term, you can lock in passive income at the specified rate for the length of the term.
For those that are more risk-tolerant, CDs may not be the right option for earning passive income.
Related Post: 8 Passive Income Ideas For 2020.
As described above, the best way to earn passive income through CDs is with a ladder approach. Keep the interest that you earn each month, should you need it, and keep reinvesting your money every year.
Now let’s go over some other advantages and disadvantages of CDs.
Advantages of CDs
Let’s go over the major benefits of a certificate of deposit.
- CDs are considered the safest form of investment.
- CDs give a guaranteed rate of return.
- There are many terms to select from.
Basically, CDs are safe and steady. They don’t provide a huge rate of return, but there’s minimal risk involved when it comes to losing capital.
Disadvantages of CDs
There are some drawbacks to a certificate of deposit. Let’s touch on those:
- You have limited liquidity. That is, you can’t withdraw your money without a penalty.
- Returns are relatively low. If you’re looking for a high ROI, you’ll need to look elsewhere.
- CDs don’t generally keep up with inflation.
The major drawbacks of CDs are simply low returns and the lack of access to your funds. In the end, CDs are still very safe and great for risk-averse folks.
Wrapping it up
Certificates of deposit are a safe investment that might be right for you. You can earn a steady stream of passive income if you don’t need access to your capital. Open a CIT Bank certificate of deposit today to start earning passive income.