In these times of recession, one wants to hold on to one’s savings and invest in sound options. One such option is the Certificate of Deposits (CDs) – these are time based deposits, quite similar to a bond. Issued by a commercial bank or obtainable through a brokerage, these allow an investor to invest for a fixed interest rate for a fixed time.
A CD will have maturity date, a specified fixed interest and can be of any denomination. The term of deposit can vary from one month to five years. While investing, it is always good to know the pros and cons of the investment option.
Advantages Of CDS As An Investment Instrument
- CDs typically offer a higher rate of interest than Treasury bills and savings account due to the higher risk associated with them.
- As the rate of interest is fixed, your return on investment is ensured despite the rate fluctuations in the market.
- CDs are insured by Federal Deposit Insurance Corporation and hence are a good investment option for single income households and retired folks. CDs are a risk-free investment.
- The return on CDs is assured and helps in financial planning.
- It’s very easy to set up a CD. One needs to just walk to their local bank and request for purchase of CD. Money from the existing savings account will be ear-marked against the CD that has been purchased. The only thing to be made sure that the bank is FDIC ensured.
- CDs can be purchased and sold through a brokerage firm. This way you can encash the CD before the maturity term without paying the penalty.
Disadvantages Of CD As A Money Market Instrument
- Money is tied down for long durations of time. Though the investor can withdraw money, he has to generally incur penalty in terms of some amount of loss of interest on the deposit amount. You can get a waiver on the penalty in case of special circumstances like disability, death or retirement.
- As the rate of interest is fixed, it is difficult to change or to take advantage of the market situation when the market rates are favorable. You will not be able to get an interest rate that favors inflation.
- Though the return rate is higher on CDs than savings account, it is much lower than other money market instruments where you can make possible investments.
- According to the federal regulations, FDIC will insure CDs up to the maximum amount of $100,000 in a single financial institution. So if you want to invest more than &100,000 you will have to invest in separate CDs in different banks!