Monday, May 25, 2009

Successful Investing In Certificates of Deposit

The stock market is in rip-roaring form of late. My neighbor just informed me of his killing in the stock market - a cool $90,000 over the past three weeks. To be sure, I am tempted by the easy money which he pocketed almost effortlessly.

Successful Investing In Certificates of Deposit
However, skepticism of this stock market rally lingers in my mind and I am not in a hurry to risk any of my hard-earned money to chase the bull. It wasn't too long ago that this same neighbor who exalted about his new found wealth was losing sleep over his credit card debts and impending foreclosure.

One will have thought he has learned a valuable lesson but the robust stock market rally has enticed him back to his speculative ways. I am less than impressed with his behavior but since I am in no position to lecture him, I can only review my own portfolio and investment strategy to see if any adjustments need to be made, in light of the exuberance.

Before we commit to any investment, we have to understand that it entails an element of risk and the higher the risk, the bigger your returns. This is the basic tenet of investing. So if your risk profile is high, you can choose to invest in stocks, bonds or commodities.

I have a low risk appetite, hence, over the years, I invested substantial savings in Certificates of Deposits. While the returns are not eye-catching, my wealth wasn't decimated by the financial crisis. On the whole, I am satisfied that the investment strategy is sound and I am sticking to it for my retirement goals.

There are very few secrets to successful investing in Certificates of Deposits. I mean, you don't have to deal with complex financial jargon or formula. Here are some reasons why I love CDs as well as tips to excel with this simple financial instrument.

1. Your Investment Is Safe.

Unlike many investments, the money deposited in a Certificate of Deposit is safe, meaning it is guaranteed by the federal government. As long as you purchase the Certificate of Deposit through an FDIC insured bank and don't withdraw the money before the CD matures, you aren't at risk of losing your money.

2. Only Invest Money You Don't Need In A CD.

As I just mentioned, you should not pull out your money before the maturity date, in order to receive the maximum benefit of a CD.

If you take money out of a Certificate of Deposit before it “matured”, you pay a penalty fee. Depending on how hefty the penalty is, it can decrease the amount of interest you earn or even eat into your principal (ie. you withdraw less than your original deposit).

Hence, you must be prepared to invest for the long haul. That excludes your emergency fund which must be liquid.

3. CDs Have Higher Interest Rates Than Savings Accounts.

I know there are many online savings account which offer attractive interest rates, but rarely will they surpass the interest rate from a Certificate of Deposit. The reason is because you are essentially giving the bank a loan when you deposit money for a specific period of time in a CD.

The time frame for the "loan" can range from 3 months, 6 months, 1 year or 10 years and in exchange, the banks have to provide a higher rate of interest than a savings account.

On the other hand, savings accounts can be withdrawn at any time, without any penalty, and therefore this money is less reliable for the bank to make any meaningful investment. Hence the lower interest rates.

4.Using A Certificate of Deposit Ladder.

Laddering will maximize your savings through certificates of deposit. CD laddering is a method of staggering your maturity dates on multiple Certificate of Deposits, which enables you access to parts of your money at different intervals.

Each time a CD matures, you can withdraw without penalty or re-invest into another Certificate of Deposit or investment of your choice. This will lower the chances of any premature termination of CDs because of tight cashflow.

5. Comparison Shop Before Investing In Certificates of Deposit.

Many people assume that Certificates of Deposit are the same everywhere. Well, CDs do vary and you should comparison shop for the best.

While the traditional, plain-vanilla Certificate of Deposit is the most popular, there are also “bump up” CDs which allows you to receive more interest if the interest rates rise before your CD matures.

“Liquid” Certificates of Deposit makes it possible to withdraw money penalty free before maturity is reached. Other CD variations include callable, zero-coupon, brokerage and high-yield, which all have slight variations of the traditional Certificate of Deposit.

With these 5 tips, you should be doing relatively well in your investment on Certificates of Deposits.


Petunia said...

When rate shopping for CDs, don't forget to look at on-line banks' CD rates. On-line banks have more to offer than savings accounts.