What’s a CD?
A CD, or Certificate of Deposit, is issued by a bank to an individual who deposits money with the expectation of earning a higher interest rate than a savings account. The higher rate is offered in exchange for promising to leave the money at the bank for a specified amount of time (typically ranging from thirty days to five years).
Essentially, a CD is a type of savings vehicle where the individual trades easy access to their cash in exchange for a higher interest rate than a standard savings account.
Improving Your Finances
Whether you are saving money for a short-term goal like a down payment on a car/home or a long-term goal like retirement, one of the biggest challenges we all face is inflation. Many are aware of but few people track closely, inflation can erode the purchasing power of your accounts over time which is why it is important to target ways to combat this challenge.
Emergency Fund
First off, establishing an emergency fund is the primary objective in improving any financial situation. Generally speaking, an emergency fund should maintain three to six months of household expenses. These funds will enable the individual or family to withstand a large unexpected expense or bridge the gap if a family member faces the loss of employment. The emergency fund assets should be maintained in a very safe and liquid account (checking/savings account, Certificate of Deposit, etc.). The purpose of these funds is strictly for an unforeseen emergency and you should focus on accounts that are accessible without a penalty of losing principal value.
As mentioned, inflation wreaks havoc on idle cash over long periods of time. As an emergency fund grows, finding ways to keep pace with inflation is key. While a checking or savings account might not offer this opportunity, a CD may be a viable option. Since the financial crisis in 2008, inflation has been extremely low and maintaining high levels of cash in a checking or savings account has not been problematic; however, forecasts are predicting a 2% or higher rate of inflation through the year 2020. This means that idle cash will begin to lose purchasing power more rapidly than we have seen recently.
Whether an individual is an ultra-conservative long-term investor or saving for a short-term goal with expectations of a high degree of principal safety, purchasing a CD may be the right answer. In addition, CD’s provide FDIC insurance (subject to limitations) and promise a specific interest rate over a specified period of time.
Other Considerations
Outstanding short-term debt should be considered in this process. Purchasing a CD offering 2% may keep pace with inflation but likely is dramatically lower than the interest rate being charged on a credit card balance. Weighing these options is an important part of determining whether or not a CD makes the most sense for your personal situation.