Thursday, August 6

Certificate of Deposit Advantages and Disadvantages

A Certificate of Deposit or a CD is a savings certificate that entitles the bearer of the same to receive interest. The certificate bears a maturity date, has a fixed rate of interest, and is issued in any denomination. The CDs are generally issued by commercial banks and the tenure ranges from three months to five years. In case, you have some extra money you can invest the same in CD even for a relatively short period of time. CDs are safe investments that are generally suitable for cash amounts that you do not need for long periods. The returns on CDs are guaranteed, which means you are assured of getting your full invested amount in addition to the interest amount that the bank will pay you for your investment.

Know More – Advantages and Disadvantages of using Debit Cards

Certificate of Deposit Advantages and Disadvantages

Advantages of Certificate of Deposit

Term of investment

The major advantage of using a CD is that you can choose the tenure for investment in CD from 3 months to five years. The longer the term of CD, the greater is the amount of interest that you receive for your investment.

Grace Period

The advantage of investment in a CD is the grace period that is granted by the Bank. Grace period is the period granted by the bank to decide your plans for further investment of the matured amount. The grace period is generally seven days.

Fixed-Rate of Interest

The CDs are the safest investments as the rate of interest is almost fixed and does not change for the entire tenure of the CD. So you need not worry about the floating rate of interest. CDs are also beneficial as they pay a higher rate of interest than the savings account

Lower risk

While investing money, investors lookout for option that offers lower risk. CDs offer investors the option of investing at lower risks. If you have some money and you are planning not to use that money for some time, you are advised to invest that money in a certificate of deposit.

More rate of interest than a savings account

The rate of interest offered by CDs is more than the traditional savings account. During tough economic times, it is easier to invest in certificates of deposits as the interest on CDs is earned at a fixed rate.

Promotes safe investment by Banks

CDs are less risky as compared to traditional investments like mutual funds and annuities. They are linked to the stock market and hence do not guarantee any fixed returns. When you invest in CDs, the banks issuing the CDs will further invest this amount into safe investments that will promote and generate growth. Thus the money is used wisely for investments.

One size fits ALL

CDs are used by individuals from low-income groups as well as individuals from the high-income groups. This helps the banks to get them a steady business by offering CDs and is a win-win situation for both the banks and the investors. Also no middle agent is required for purchasing a CD. The investors can directly contact the bank for their investment in CD.

Disadvantages of Certificate of Deposit

Penalty

The major disadvantage of investing in CD is that once you invest in a CD, you cannot withdraw your money before your term matures. In case you do so, the bank charges a penalty for the same.

Automatic Rollover

The other biggest disadvantage is that in case you do not decide about what you have to do with your mature funds, the bank will automatically renew the same at a prevailing interest rate which may sometime be much lesser as compared to other investment options.

Certificate of Deposit Advantages and Disadvantages

Limited liquidity

The other disadvantage if the owner cannot easily liquidate the CD in case of an emergency. They are usually charged a penalty for premature withdrawal which may result in loss of interest.

Inflation risk

The interest rate on CDs does not increase with inflation and thus your time value of money will decrease with increasing inflation.

Low Returns

As seen above, the rate of interest of CDs is higher than that of a savings account. However, they are not as sound an investment as some other options like shares, stocks, and bonds. In other words, CDs yield low returns and could take a significant time to mature.

Tax Payable

Another disadvantage of investing in a certificate of deposit is the tax payable on the interest accrued. This can become a problem because it will eventually eat into the investor’s savings.

In conclusion, it is important to weigh the pros and cons of certificate of deposits. Especially before making a valuable investment. Also, one must be clear about what they are looking for in terms of the said investment.

Know More – Advantages and Disadvantages of Mutual Funds

Pros and Cons of CDs

PROS

CONS

Term of investment

Penalty

Grace Period

Automatic Rollover

Fixed-Rate of Interest

Limited liquidity

Lower risk

Inflation risk

More rate of interest than a savings account

Low Returns

Promotes safe investment by Banks

Tax Payable

One size fits ALL