I’m going to try and keep this short today, but if you are thinking of investing in certificate of deposits, think again. Though safe, these investments yield little to nothing in interest. Even if you can get 5% on a certificate of deposit (which is unlikely in today’s market), you will still only be doing slightly better than the current inflation rate. Now some of you may be thinking this:
But Jeffry, not only is a certificate of deposit safe, but I can borrow against it when I need some money.
Problems with Investing in Certificate of Deposits
Hmm…borrow your own money? That sounds like a very smart idea (not). You see, savings and commercial banks use certificate of deposits for one thing – to raise money for use in lending. So they take your money, pay you a low rate of interest, then turn around and lend that money to someone else at much higher rate of interest. Let’s take the example posed above, if you were to get 5% interest on your certificate of deposit, and then took out a personal loan against it, you will probably end up paying somewhere around 6-8%. You will be losing 1-3% on your money. Not a very smart idea from an investment point of view.
Another problem with investing in certificate of deposits is that you agree to tie up your money for a certain period of time. Further, to get a better rate of interest, you have to agree to tie up your money for much longer periods of time. If you break a certificate of deposit early, you will forfeit a substantial amount of your earnings in early termination fees.
When Investing in Certificate of Deposits Make Sense
In the example above, I talked about borrowing from your certificate of deposit. Normally not a good idea, however, if you are trying to build up good credit or restore your credit ratings, then this is a good short term solution for doing so. The loan is easy to get, and if you make your payments on time, you can boost your credit in a relatively short period of time.
If you are in retirement and want to maintain low risk on your money, but can afford to tie it up in a certificate of deposit for a while, then it makes sense.
Another viable use of investing in certificate of deposits is when you need a specific loan like an auto loan. In almost every case, the bank is going to want collateral for issuing the car loan, and a certificate of deposit is an excellent way to fulfill that requirement.
So my overall take is this – if you are looking to really make some money, steer away from certificate of deposits and focus more on better earners, like bond and mutual funds, and real estate investments. But if you are looking to build credit or apply for particular types of loans, then investing in certificate of deposits can be a vehicle to get you there.