Risks of Certificates of Deposit

Although Certificates of Deposits can be among the safest of all investment products there are also some potential risks involved as well. Before investing in a CD, it is imperative to consider the follow risks of Certificates of Deposit.

Know Where Your Money Is Going
Perhaps the greatest risk of all is in not knowing exactly where your money is going when you invest in a Certificate of Deposit. Just be careful to investigate the financial institution where you intend to purchase your CD. If that particular establishment is not FDIC insured then you might want to think twice before placing your money on account there. This is especially important if your investment is being brokered. Just because the financial institution has a name that ‘sounds like a bank’ doesn’t mean that it is indeed a bank, or even one that is FDIC insured. If it is, then you know that up to $250,000 will be safe to place on deposit in that bank.

Limit the Amount You Place in Any One Bank
Once you have established that the bank where you intend to purchase a CD is federally insured, keep your total investment at or below $250,000 in that one bank. Of course this is only logical since the FDIC will only insure a maximum of $250k in a single bank. If you have more money to invest then it would be a good idea to find other banks that are also FDIC insured to hold your money. Something else that should be considered is that you may also have other types of accounts in the same bank. The sum total of money that will be insured is $250,000 USD which includes all types of savings and checking accounts, including CDs. Limit the total money you have on account in each bank to the maximum insurable amount ($250k).

Avoid Long Term Callable CDs
If you have taken out a long term CD that is callable and are given a good interest rate for a 10 year period you obviously are looking forward to making that money when your CD matures. Say for example you are given a 8.5% interest rate on your callable CD and the bank, for economic reasons, begins offering CDs at the rate of 7.1% or even 6%. Since you have a callable CD the bank is free to call it at any time and you have no choice but to cash it in or reinvest it at their current rate. On the other hand, if interest rates go up you would still be locked in to your 8.5% while others are now getting 9.1% for example. Callable CDs only benefit the financial institutions when it comes to not paying a penalty for early withdrawal. Keep that in mind. You would be better off taking a lower interest rate with a one year CD than to take a higher interest rate with a callable CD.

Don’t Forget about Inflation
There are other things to be considered as well, such as inflation. Many experts advise that it is always best to place your money (if you are intent on CDs as investment instruments) in short term CDs. Along with the above mentioned risks you might want to consider the fact that the interest you earn on your CD may not be as much as the amount of inflation that has occurred over those years. So if you invest $10,000 in a 20 year CD at an interest rate of 6% and inflation over that period of time went up 10% then you have actually lost money in the process! Yes, you will still have your initial $10k but it will be worth less than $9k at redemption based on the purchasing power after inflation.

Keep these risks of Certificates of Deposit in mind before placing your money on account. The best advice is to use short term CDs and if you have enough to invest to bring your over that magic $250k amount, use several banks so that all of your money will be insured. Even though there are some risks, CDs are still considered to be one of the safest investment instruments on the market.

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