5 reasons why CDs are perfect for low risk investors
August 14, 2015
Are you a low risk investor? Just about everyone should be, at least with some portion of their investments.
Even if you fit the profile of someone who can afford to take investment risk - long-term oriented with positive cash flow and a willingness to accept market fluctuations - some portion of your wealth should be in safe investment options. These provide liquidity for immediate needs, act as a reserve against unexpected expenses and can be a stable counterweight against the more erratic parts of your investment array.
Certificates of deposits can be perfect for low risk investing, whether that is your primary orientation or just a complementary role in your overall portfolio.
Here are five reasons CDs can do the job so well:
1. FDIC guarantee
When it comes to an absolute assurance of not losing money, insurance from the Federal Deposit Insurance Corporation is the backing you need for your investments. CDs from FDIC-insured banks are among the deposit accounts covered by this guarantee. The FDIC insures deposits in U.S. banks for up to $250,000 per depositor, per bank. If you have an Individual Retirement Account and a personal account, these are considered separately and so you can get an additional $250,000 in insurance at the same bank.
Joint accounts are insured for up to $250,000 per co-owner of the account, so these can also exceed $250,000 in total coverage. If your individual accounts exceed $250,000, you can obtain additional insurance by spreading the money around to different banks.
CDs at credit unions are also covered up to the same amount, through the National Credit Union Administration.
2. Locking in a CD rate
Having your principal guaranteed is one aspect of risk management, but so is knowing what return you are going to get. Deposit accounts like money market and savings accounts are also covered by FDIC insurance, but their interest rates are subject to change at any time. With a CD, you can lock in an interest rate for a specified period of time, and that type of certainty fits the objective of low risk investing.
3. Predictable cash flow
Not only can you lock in CD rates, but the defined term length of CDs tells you exactly when your money will be available. This allows you to time your CD terms to fit planned expenses - think of this as a form of just-in-time inventory management for your money.
4. Choice of time frames
Not only are CD terms predictable, but you can choose anything from a one-month to a multi-year term. This allows you to plan for multiple future needs at once, or use the technique known as CD laddering to provide a regular stream of cash flows from maturing CDs.
5. Opportunities for higher rates
CDs offer certainty, but you still have an opportunity to improve your returns if you shop around and compare CD rates. The highest CD rates are usually significantly better than the average, so it is well worth your while to do some comparison shopping.
Within the limits of FDIC insurance, the only way you can lose money with a CD is to sign up for a long-term one and then cash it out quickly so that you incur an early withdrawal penalty before you've had a chance to earn much interest. Plan your time frames correctly though, and CDs will be among the most reliable investments possible.
Tell us: Have you invested in CDs or employ strategies like CD laddering?
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