Certificates: A Low-Risk Savings Option

Are you looking for a relatively safe, low-risk investment, but want a higher return than a standard savings account?¹ Consider a certificate of deposit (also known as a CD), in which you invest an amount of money at a specified interest rate for a pre-determined length of time. Earned interest is deposited into the certificate account either monthly or quarterly. That interest adds up over time, allowing your savings to grow.

How long your money stays in the certificate of deposit—also called the terms—can range anywhere from 3 months to 5 years or more. Typically, longer investment periods yield higher interest rates, increasing the rate of return. When the certificate of deposit matures (the date you can withdraw your funds), you have the option to renew the certificate at the current available rate or close it and have the cash available to spend or to invest the money in other ways to meet your overall goals.²

Traditional certificates have fixed rates, but many financial institutions also offer variable rate certificates, in which the term is still fixed but the interest rate changes based on pre-determined financial factors.

The benefit of a certificate of deposit is that you can calculate what your return will be, as you know how much interest you will earn and when the investment matures. And certificates of deposit are insured by the FDIC for up to $250,000, making them safe investments. However, there are penalties for withdrawing money from a certificate of deposit before the maturity date.

Many people use certificates of deposit as a way to save the money they will need for a big ticket item in a few years, such as a house purchase, a car or boat or vacation, or college tuition. Some include certificates of deposit in their investment portfolio to balance risk. Others use certificates of deposit as a disciplined savings tool, as they are not likely to be tempted to spend money that carries penalties if withdrawn early.

Certificates of deposit are available at most financial institutions, however the minimum deposit requirements, rate of return, time until maturity, and other considerations vary, so be sure to do your research to find the best option for you. When choosing a certificate of deposit, think through these questions:

1. What are your savings goals? How much money are you trying to save, and when will you need it? What will you use the funds for? You really want to think about this carefully, and consider talking to a professional. You’ll want to choose a certificate that will mature before you plan to use the money. For example, if you’re comfortable with a certificate that you cannot touch without incurring a penalty, the interest rate will be better. Think about your big picture and your overall goals for your individual comfort level and short-term or medium-term needs.
2. What is the best interest rate that works for your goals? Find certificates with the highest interest rates with terms that work within your savings timeframe and with minimum deposits that you can afford. Will those rates still be attractive in a few years? If so, lock in that rate by choosing a long-term option. If, however, you think that in general interest rates may soon be higher, choose a short-term option. You may also want to consider taxable versus tax-deferred options.³ These are great questions to ask a professional before you make your investment.
3. Can you cover your expenses before the certificate matures? Remember that certificates of deposit do not make a good emergency fund, because of the penalties for early withdrawal. Consider putting aside three-to-six months of expenses in a savings account that you have immediate access to before making longer-term investments. Also, remember that even though you cannot access the funds in a certificate of deposit until the maturity date, you will need to pay taxes³ on the interest earned in that fund every year.

Some people find a way to invest in certificates of deposit while still maintaining cash flow by using an approach called a “ladder”—choosing several certificates with different maturity dates. This approach allows sums of money to become available at regular intervals and makes it easier to take advantage of higher rates as interest rates change.

Many financial institutions offer different types of certificates of deposit. For example, some offer an IRA option that is an individual retirement account with the funds invested in certificates of deposit. Others offer specific opportunities at pre-determined intervals before the certificate matures, such as options to increase your rate (often called a step-up or bump-up) or deposit more money into the certificate.

Explore these other relevant savings options before you decide:

¹ Federally insured by NCUA up to $250,000
² UFCU Certificate dividends are paid quarterly. Dividends are calculated by the daily balance method. Dividends are based on UFCU's earnings at the end of a dividend period, and cannot be guaranteed.
³UFCU does not provide tax or legal advice. For such guidance, please consult a tax and/or legal advisor.