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Investing in CDs - A Wise Choice?

Jun 11, 2008
A languishing dollar coupled with rising interest rates has recently put the focus back on Certificates of Deposit, which were considered outdated and defunct not too long ago. Certificates of Deposit, or CDs as they are called, give the customer an option of a fixed return on money without losing capital due to the volatile nature of the stock market. Since the money is tied down for fixed periods of time, one can also be assured of a fixed amount of return with interest rates typically higher than the current savings rate. While CDs were not a viable option in the bullish years of the stock market, they are now back in focus due to the current slowdown in the US economy. This newfound interest in CDs is almost entirely fueled by the prospect of rising interest rates in the near term future.

When customers invest in a CD, a financial institution provides the investor with a paper certificate, which is a testament of the investment made. Hence the term "certificate of deposit." Furthermore, the bank also keeps the investor updated with periodic statements on the current value of the CD. Certificates of deposit usually have a fixed interest rate that varies based on the maturity period of the CD. As a rule of thumb, higher rates of interest are given to CDs that have a much longer maturity period.

Most CDs provide the investor with the choice between withdrawing the interest on their CDs to a saving bank account or compounding them back into the principal amount. While the former offers the investor a source of liquid cash every six months, it is the latter which is usually preferred due to the excellent returns one gets at the end of the maturity period through compounding interest. After the maturity period, one may withdraw the CD or invest it back again into another Certificate of Deposit. Withdrawing the money generally involves a small penalty such as the withdrawal of the interest accrued for the last six months of the tenure while investing in CDs back again is welcomed by the bank.

One should always take a proper bird's eye of the current market scenario before investing in CDs. A bullish market will render the CD less worthwhile as the principal amount could be invested in other places that provide larger returns. However, investing in CDs during an economic slow-down may turn out to be a wise choice as the investor effectively protects herself from declining market rates and gets a much higher rate of interest than in a regular bank savings account. Besides, the biggest advantage of investing in CDs is that the investor is always assured of a fixed sum of money at the end of the tenure, which is always greater than the principal amount. This has the effect of virtually eliminating the risk factor in investing. With the likes of Warren Buffet predicting a pending recession in the near future, more and more companies and individuals alike are investing their hard earned capital back into CDs.
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