Savings is a part of life. Whether you’re saving for a vacation, a house or a college fund for your kids, it is important to know the best way to put your money to work and make it grow faster. Today, we want to share a savings trick (that not many people utilize, unfortunately) that could save you hundreds or even thousands a year.
The trick is to save your cash funds in a Certificate of Deposit (CD) account if you have money that you plan to put away for longer periods of time.
Now you may be wondering: “I already have a savings account for my dream vacation, so why does it matter and how is it any different?”
One word: inflation!
The average inflation rate in the U.S. hovers around 2% annually, meaning that if you park your cash somewhere that has a rate of return lower than 2%, you’re essentially ‘losing’ money by erosion through inflation.
The difference between a CD and a traditional savings account
The biggest difference between the two saving methods are that CD’s come with a maturity date, and require a one-time deposit. You put in a minimum deposit, say $500, and the CD is locked in for a period of 6 to 60 months, depending on how soon you’re expecting to use the funds. Therefore, you can’t access the funds until the CD matures or you risk losing some, or all, of your interest earnings.
Now hold on a minute, that sounds like a lot of restrictions doesn’t it? So what exactly are the benefits, then?
The benefits of CDs
- High rate of returns
Quite simply, given that CD’s are locked into a fixed maturity term, what attracts people are the high interest rates. Another fact to note is that the longer the maturity date you choose, the higher the rate of return.
A traditional savings account offers roughly 0.15% APY, whereas a CD account offers roughly 3% APY. When talking about having big bucks in your savings account, you may be foregoing hundreds, and potentially thousands, in interest income every year. To add to that, many big banks only offer a measly 0.02% APY, so remember to always let your money work for you!
See DECU’s current CD rates.
- Secure and reliable
CD’s are a great investment vehicle if you know when and how much exactly you need in the future. Since CD’s are also locked for a fixed rate, no matter how much the market fluctuates, you’ve secured in that rate of return. CD’s are also FDIC insured, so it means that it’s risk-free to all parties involved.
- Quells impulse spending
A CD could serve as a psychological benefit for impulse spenders that have funds stashed in an easily accessible savings account. Since you can’t access it without getting penalized, it helps keeps those funds out of sight and out of mind.
- Flexible maturity dates
You can choose a maturity date option that works best for you. If you start a college fund for your high school kids and need it in 4 years, there is an option for that. If you’re savings for a new car by the end of the year, you can do that too. Here at DECU, our CD’s have different maturity dates so you can match your needs to the timing of your goals or life events.
The risks of CDs
- Funds are less accessible
CD’s lock-in your money for a set period of time and if you withdraw your funds before the CD matures, you void some or all of your interest earnings. Therefore, CD’s are not meant to be used as a placement for emergency funds. To be able to gather funds in a pinch, a high-yield savings account or a money market account would serve better during emergencies.
- Rates are locked
Since CD rates are locked in, it’s great when the market rates decreases. But if market rates so happen to increase, the opportunity cost of that will be against your favor. However, there is a strategy called CD laddering that hedges against this particular risk.
CD’s are a great option for your savings funds and investment portfolio when you have money sitting in low-interest saving accounts. If you plan to save some of your money for a certain period of time, it makes sense to ensure that the money does not lose its value due to inflation.