The Weaknesses & Strengths of a Certificate of Deposit

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Buying a certificate of deposit is an effective way to keep your money safe while earning interest. When you buy a CD, you agree to keep your money invested for a set period, and in exchange you get a guaranteed return that could pay you a steady and reliable income.

Safety

  • If you choose a bank that is a member of the Federal Deposit Insurance Corporation or a credit union that is a member of the National Credit Union Administration, your money is protected up to a limit of $250,000, as of 2010. This safety is an important consideration, especially with money earmarked for short-term purposes. When you have a longer time horizon, you might be able to recover from a downturn in the market, but with short-term money your primary consideration should be safety.

Predictable Income

  • A certificate of deposit provides you with a predictable stream of income you can use to meet expenses or build up your portfolio. With other types of investments, such as bond funds, you might not know ahead of time how much you will make, but with a CD you do know exactly how much you will receive. That makes it easier to design a budget and predict how much income you have coming in. Knowing ahead of time how much you will receive also makes tax planning a lot easier.

Inconvenience

  • When you invest in a CD, you agree to keep that money invested for the entire term of the instrument. That means you do not have access to your money in the meantime, and if you need the money in the meantime you face a penalty for early withdrawal. Before you invest in a CD, ensure that you can keep the money invested for the full term before you sign up.

Low Rates

  • Although the rates on certificates of deposit tend to be higher than the rates on checking and savings accounts, they still tend to be low compared to many bonds and mutual funds. When it comes to investing, the safest investments tend to have the lowest yields, so it is important to weigh the safety of a CD against the lower rates.

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