There are all kinds of investment options out there these days; some of them can be quite interesting. One option that a lot of people tend to overlook is the certificate of deposit that is offered by their local bank. It may not seem like it but these should be an important part of everybody's portfolio. So what is it that makes a certificate of deposit so interesting?
If truth be told a certificate of deposit is not particularly interesting at all. That is in fact the great appeal of them for most people. These days there are all kinds of exotic investment options out there offering all kinds of products that people really don't understand. The good old CD on the other hand is a nice simple investment that you can make that will provide you with a decent return for virtually no risk. That takes a lot of the stress out investing your money, which is probably a lot more useful than having an interesting investment.
A certificate of deposit account is similar to a savings account in many ways except that when you deposit your money you are lending it for a fixed period. Banks make their money by taking the money that you deposit and lending it out to other people as mortgages and other loans. One of the problems that they face is that when you put your money in a checking account they don't really know when you will come back to withdraw your money. This limits the amount that they can lend out since they have to maintain a reserve so that they can meet the demand for withdrawals.
To get around this problem the banks started offering certificates of deposit. These require that you commit your money for a specified period of time; it can range from six months to five years. In exchange for committing your money for this time you get a higher interest rate. This is beneficial to the bank since they know when the money will have to be paid out they don't have to maintain a reserve and they can put more of it to work in the form of mortgages, making more money for the bank.
Obviously since the banks have a vested interest in encouraging people to invest in CD's they put a great deal of effort into promoting them. In order to attract investors to give up their money for a specified time period they have to offer interest rates that are much higher than you would be able to get from a more liquid investment like a savings account. This is a big part of what makes a certificate of deposit such a great investment, the return is much higher than you would get form other products with a similar level of risk.
That brings us to the other great advantage of a CD, they have virtually no risk. The reason for this is that they are treated just like a bank account which means that they are insured by the Federal Deposit Insurance Corporation. That means that even in the unlikely event that the bank fails your money is safe up to the maximum coverage of $250 000. Since your deposit is guaranteed you don't have to be worried about losing your money which makes the process of investing a much simpler affair.
In most cases when you are investing your money have to take a look at the potential rewards and you have to try to assess the risk. Usually this can be tricky to do since you usually don't have all of the information. This is not the case with a certificate of deposit; you already know that there is no risk which means all you have to do is determine what the returns would be. This is fairly easy to do as well since you are told right up front what the interest rate is so all you have to do is find the best one available.
When you are looking for a certificate of deposit it is a good idea to shop around to make sure that you are getting the best rate. It is shocking how big of a difference there can be from one bank to another when it comes to interest rates. Given that all CD's are basically the same this is hard to explain but it is nevertheless the case. In general you will find that the smaller banks have the best interest rates as they need to be more aggressive to capture the business from the bigger banks.
The other big factor when it comes to interest rates on CD's is the length of the deposit. Obviously nobody is going to tie their money up for five years if they could get the same return by investing in a six month term. Therefore you will find that the longer the term the better the rate will be. You will need to decide how long you are prepared to keep your money tied up in order to get the best possible return. Obviously the higher the interest rate you can get the better but you do have to keep your financial needs in mind as well.
In general a certificate of deposit is a useful part of your investment portfolio. Compared to things like the stock market the returns are not all that good but you won't find a better combination of risk and return on other investment. A CD can provide you with a great deal of stability which is important for most people. Certainly you don't want to have all of your money invested in a certificate of deposit but it is certainly a good idea to have some of it there just to make sure that you don't lose everything in the stock market crash.