When preparing for retirement, there are so many investment opportunities out there that sometimes it’s hard to choose. An IRA can hold different investments. Money can be invested in bonds, stocks, mutual funds, and others. A person planning for retirement may also wish to consider opening a certificate of deposit (CD). However, it’s essential to consider the pros and cons of doing so, as it is with every type of investment, to make the right choice for your goals.
Certificate of Deposit
A certificate of deposit is a safe, low-risk savings instrument offered by credit unions and banks. These time deposit accounts, like a bond, pay interest over a specified term length. This period can generally be anywhere from three months to 5 years.
Certificates of deposit shouldn’t be confused with savings or money market accounts. While these accounts allow for withdrawals, CD accounts expect an investor to withdraw only at maturity. As an investor, it’s recommended to always review every investment option available comprehensively before investing.
Opening a Certificate of Deposit
When opening a certificate of deposit account, it’s essential to compare the CD options. Generally, for example, online banks may offer higher interest rates and low fees. However, make sure you consider withdrawal penalties, renewal policies, accessibility, minimum and maximum maturity terms, and required deposit. Also, with CDs, just like any other investment vehicle, there are pros and cons.
Pros of Using Certificates of Deposit for Retirement
Certificates of deposit have the potential of high returns when interest rates are high, and this is what attracts people mainly in high-interest-rate environments. This and several other reasons are benefits of using CDs for your retirement. Here are more advantages.
· Safe and Low-Risk Investment
When you invest in a CD at a bank, it is backed by the Federal Deposit Insurance Corp. (FDIC). Your money is safe. This is because the principal amount is insured in case of bank failure. The insurance coverage is up to $250,000 per depositor, insured bank, and ownership category.
· Better and Guaranteed Returns
Compared to other types of investments or deposit accounts, certificates of deposit investors guarantee a specific yield for the agreed period. This means that even if the interest rates in the broader economy fall, your rate remains constant up to maturity.
· Higher Return Rates
CD account holders can’t withdraw their money at a moment’s notice like a savings account. This aspect of the CDs makes banks pay investors a higher yield for locking money for the agreed time set. But this depends on the bank, term, and the present market interest rates.
· Certificate of Deposit Laddering
CD laddering is a technique that allows investors to keep their money accessible and liquid while considering the changes in interest rates. Laddering refers to opening several CDs with different maturity periods. This way, an investor continuously has CDs maturing.
· No Monthly Maintenance Charges
Money market and savings account holders may pay a monthly maintenance fee which affects your interest negatively. But with CD accounts, you don’t pay any maintenance fees.
Cons of Using Certificates of Deposit for Retirement
There are some pitfalls that any CD investor should keep in mind when investing.
· Limited Liquidity
One significant drawback of certificates of deposit is the inability to access your money quickly in case of an unexpected need. Other accounts such as checking or savings allow withdrawals through debit or ATM cards or by writing checks against the balance.
· Withdrawal Penalties
While you are guaranteed a specified interest rate for holding until maturity, should an investor withdraw early, they must pay a withdrawal penalty. This can be a percentage or flat fee. Some penalties may cost you all of the interest earned.
· Inflation Risk
When inflation is rising, CD rates are locked in. This means that your money can lose its purchasing capacity as inflation overtakes interest gains.
· Low Relative Returns
CDs yields may be favorable when interest rates are high, but yields are low when interest rates, in general, are low. Expected returns are generally lower than with high-risk assets like stocks or stock mutual funds. Also, when compared to liquid bank accounts, if an opportunity to grow your money comes along and your money is locked in a CD, you miss the chance.
· Re-investment Risk and Tax Burden
When interest rates are low, investors face the problem of re-investing in lower-yielding CDs. Also, at maturity, you will pay tax on the earned interest which reduces your income.
In summary, CDs are a safe, low-risk savings tool, but with limited returns.
About the Author – David Milberg
David Milberg is currently a Senior Vice President at Milberg Factors. David has been with Milberg Factors, Inc. since 1995. Prior to joining Milberg Factors, he was a Vice President of Lehman Brothers in the Investment Banking Division, where he worked on stock offerings, debt offerings, and mergers and acquisitions. David Milberg began his career in finance at Bankers Trust Company in the Loan Sales and Syndications Group, which was responsible for syndicating and selling participations in loans to leveraged buyouts.
David Milberg is a graduate of Princeton University and received his MBA from the Columbia University Graduate School of Business.
Find out more about David Milberg and the team at Milberg Factors today by visiting the company website at https://www.milbergfactors.com/bio/david-j-milberg/.