Simple financial advice. Because life doesn't have to be so complicated.


Learn more about CDs (Certificate of Deposits) and whether the investment makes sense for you

Written by on June 3, 2018 in CD, entrepreneurship.

Last update on Dec. 27, 2019.


CDs are very low risk because they are insured money "in-the-bank". Short of a catastrophic breakdown in the US financial system, you won't run into issues getting your money back from a CD.

In the United States, CD's are guaranteed by the FDIC (for banks) and NCUA (for credit unions).

Because of the limit on withdrawals, they generally carry higher interest rates than a standard savings account, with the same protections. For someone who is looking for an entirely risk-free investment or a way to earn money at a higher rate than a standard savings account, CD's are a great investment. In particular, people who are closer to retirement age and not looking to take on risky investments will find the guarantees from FDIC and NCUA to be very appealing.


Terms



CDs can range between a month and a decade. Generally most CDs last about 3 to 5 years. This is institution-dependent, but the shorter the term, the lower the interest rate. Remember that the interest rates are locked in!

If you need to do an early withdrawal from a CD, generally the bank or the credit union will take several months worth of interest from the CD. This isn't a great way to build up capital and you should avoid this scenario if possible.

The way to avoid that scenario is to avoid putting money that you will definitely need in a CD. Generally, I recommend placing about 15% of your savings in cash, so that you can avoid situations where you really need the money in a pinch.

It's possible to find banks that will offer CDs with a variable rate. This sounds great for those looking for a higher rate of return with the same insurance guarantees. An example is, what people have called "bump-up" CDs. These CDs can have a one-time or a multi-time adjustment to the interest rate, benchmarked to an agreed upon metric.

In other cases, you can have a CD that tracks the stock market. It can track the S&P500, bond markets, LIBOR rate, or any other financial tracker. These CDs are more difficult to find and can have a lower rate. If you're looking to put a large amount of money into a CD, you can negotiate a special CD package with a specific bank. Generally, this will be available if you make a 6-figure CD deposit (but it depends on the specific bank).

How to get a better rate?



Depositing more money will generally get you a higher rate. But this is very institution-dependent, so it's important to pick the right institution.

Small institutions and credit unions will give you a higher rate than larger banks

A longer lock-up term will give you a higher interest rate.

CDs based on a person will get a higher CD rate than a business. If you are a sole proprietor, it's important to open it up for yourself and not your business.

Does the investment make sense?



I would recommend very few people put money into a CD.

Let's talk about investing.

Investing is about balancing risk and return. Higher risk will generally get you a better return over time, but you have to take on the right kinds of risk. For example, buying a failing restaurant and trying to turn that around is a very high-risk business. Unless you happen to be a savant at turning about restaurant businesses or Gordon Ramsay, you will lose your money. Investing in the stock market is a much safer investment. Even buying an online business and running that is a reasonable risk.

What's wrong with a CD


The lock-up period makes it difficult to have liquidity. That means it is hard to use the money when you need it. If you can't use money when you need it, it's actually less valuable than having it ready to go. A bird in the hand is worth two in the bush. In a similar vein, a dollar in your savings account is worth two in a CD.

Take a look at this chart.


The stock market almost always goes up. It returns generally 8% every year.

Don't know how to pick stocks? Just put money in an index fund. It will return 8% per year, maybe minus 1% for fees. You will still make 7% per year and you can withdraw it any time.

But what if you're worried about losing your money?

You shouldn't be worried about losing your money.

The stock market always comes back up. You just need to wait it out (and sometimes that will take a couple years of patience). But if you're not willing to wait that time, you need to find a different way to invest.

Over the long-term, the difference between CD's (3% rate) and stocks (7% percent return) accumulates over time. Over a 20 year period, if you invested 1k in CD's, you would have 1800 dollars. If you invested in stocks instead, you would have 4600 dollars. The difference is huge, so don't invest poorly by putting money into CD's.

Even if you assume that you invest in the top of the market and there is a market crash. Say there is a terrible market crash that kills 40% of your investment right away and takes two years off your investment because that's how long the market takes to get back to growth. I'm talking real big recession.

You would still have 2397 after 20 years. This is still higher than the CD.

The power of cumulative interest compels you!

Another way to invest is to buy an online business. They will return a higher value. They require that you put some time in to grow them, but I've made 5-7 thousand dollars consistently on investments of 130-170k.


That's a 46% return on my investment (and those assets are worth 180-200k) now.

Read more about how to run a small business

Not everyone has the vision, the skill, or the drive to run their own business. But if you're living a life worth living and want to be challenged, there's nothing quite like running your own business to give you high returns and challenge yourself.

Jimmy Wales, the co-founder of Wikipedia, was 51 when he started Wikipedia. Running businesses becomes easier as you get more experienced, savvy, and good with money.

Conclusion



CDs are a reasonable form of investing, but you can definitely get higher rate of returns and more money elsewhere. I would personally recommend keeping a small cash cushion for emergencies, but invest the rest in stocks + buying small businesses.


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