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CDs 101: A simple introduction to saving and investing

The safety and guaranteed return offered by CDs make them an attractive option for people of any age.

By Jennifer Cotten, Wells Fargo District Manager

In today’s economic environment, many Americans are focused on fine-tuning their financial management and finding the most effective and secure methods of investing their earnings and saving for the future. And, considering recent market volatility, many folks are turning to certificates of deposit, more commonly referred to as CDs, as a low-risk investment for their hard-earned cash.

What exactly is a CD?

A CD is a special type of deposit account offered by a financial services institution that typically pays a higher rate of interest than a regular savings account. CDs are similar to savings accounts and differ from other investment options, such as stocks and bonds, in that they are insured by the Federal Deposit Insurance Corporation (FDIC), up to applicable limits, and are virtually risk-free. CDs differ from savings accounts in that they have a specific, fixed term. Generally, CDs also have a fixed interest rate, yet some institutions offer variable rates.

By purchasing a CD, the consumer is agreeing to keep his or her savings on deposit for an agreed-upon term. Because of this, the financial institution issuing the CD usually pays higher interest rates than they do on accounts from which money may be withdrawn on demand.

Typically, CDs are held until maturity, and when cashed-in or redeemed, the consumer receives the money originally invested plus accrued interest. CD terms vary in length, with the average range between one and two years. It’s important to note that if a CD is redeemed before it matures, an “early withdrawal” penalty may be assessed.

What makes a CD right for you?

There are a number of reasons a CD may work for you. Many people begin their savings plan by establishing an emergency savings fund, and once that’s complete, they look to the market to begin investing funds. However, when the market is volatile, and you are looking to avoid riskier investments, a CD may be the right fit for you.

When considering opening a CD, there are a few key factors to keep in mind…

  1. Financial goals: Before you make any investing decisions, sit down and take a holistic look at your entire financial situation, especially if you’ve never made a financial plan before. The first step to successful saving and investing is determining your goals and risk tolerance (the amount of risk that you are willing to accept regarding your finances). It is a good idea is to have the help of a financial services professional as you make your financial plan. CDs and cash equivalents, such as savings deposits, money market deposit accounts, money market funds and treasury bills can be an important part of a diversified portfolio.
  2. Maturity timing: Be sure the term of your CD matches potential cash needs you may have in the future. That way you avoid having to pay a penalty to close the CD early if you need the funds.
  3. Rate and payment method: When opening a CD, you should receive a disclosure document with information including the interest rate on your CD and whether the rate is fixed or variable. Be sure to ask how often the financial institution pays interest (for example, monthly or semi-annually) and confirm how the interest will be paid.
  4. Early withdrawal penalties: Be sure to find out how much you’ll have to pay if you cash in your CD before maturity.

The best bet for determining whether a CD is right for you is to be thorough in researching your savings and investment options. It’s important to be upfront about your risk tolerance and have a good savings foundation before venturing into investments that may be higher in risk. And, know that CDs are for investors of any age. They are a financial tool to accumulate funds by earning a guaranteed interest rate on your investment. CDs allow you – at a declared interest rate and a term – to save and grow your savings.

Jennifer Cotten is a district manager for Wells Fargo in Houston.

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