Benefits & Risks of Certificates of Deposit

Certificates of deposit are investments offered by banks and brokerages in which investors contribute a specific amount of money to an account but cannot withdraw it for a specified period of time. These investments last at least a week and do not have a maximum maturity length.

The biggest benefit of a certificate of deposit is the ability to lock in an interest rate for the life of the investment. This fixed rate allows investors to count on receiving a guaranteed rate of interest for the life of the investment regardless of what happens in the market. Certificates of deposit are very secure because they are insured up to $250,000, so even if the bank or brokerage firm goes bankrupt your money is safe. They also offer flexibility, as you can choose the amount of money you want to invest and the length of the investment. The more you invest and the longer the term of the investment the higher your interest rate will be. You can also choose whether you want the interest paid to you monthly or reinvested into the certificate of deposit.

One of the downsides of certificates of deposits is that they yield a smaller return than stocks and bonds over time because they are not as risky. They can also be less attractive during periods of rapid inflation, when they can devaluate. Though there are many options initially, once you invest there is very little you can change, regardless of what the market does. Certificates of deposit have minimal liquidity because of the stiff penalties that are imposed when you withdraw your money early. Legally, banks must impose a penalty of at least seven days of interest, but there is no limit, so banks generally charge a few months of interest.

Certificates of deposit are best for very conservative investors who are looking for a fixed income. Since they are guaranteed it is easy to budget your money. They are also valuable in short-term situations when you cannot afford to risk your money but want a higher rate of return than a savings account provides.