If you are looking for a safe place to store your money while earning a return, you may be considering opening a Certificate of Deposit. A CD is similar to a traditional savings account, but your bank will pay you a higher interest rate in exchange for blocking your funds for a fixed period of time. The trap for this additional earning potential? Most CDs will charge you a penalty if you need your money before your term ends.
At present, however, this additional earning potential is not so much to celebrate. The best rates on 3-year CDs are around 1%, which means your money will be locked in for a long time with limited benefits.
âI tend to avoid CDs in today’s environment because the interest rates on them are not significantly higher than those in the money market and other deposit accounts,â says Andrew Feldman, CFP, chairman of Illinois-based AJ Feldman Financial. “And most CDs block your funds and are illiquid.”
Depending on your financial goals and risk tolerance, CDs can still make sense. However, there are other options to minimize your risk and maximize your income.
1. Shares paying dividends
Some companies regularly pay part of their profits to shareholders. Big names like Home Depot and Starbucks pay dividends above average CD rates. Some companies also have a long history of raising dividends. For example, Procter & Gamble has increased its dividend for 65 consecutive years.
Investing in dividend paying stocks can potentially generate a higher return than CDs, but there is also a real risk that you will lose your capital. Buy a stock for $ 20 a share today, and it could be worth $ 15 a share in six months.
Kimberly Foss, president of Empyrion Wealth Management in Roseville, Calif., Explains that because stocks can come with such risk, you need to ask yourself what risk you are willing to take. Although this risk can be significant in the short term, it decreases in the long term. This is why you should plan to hold stocks for a period of at least three to eight years.
Many financial advisers advise against choosing individual stocks. Mari Adam, senior wealth advisor at Mercer Advisors, says that if you choose this option, it’s best to spread your risk among a few stocks and other investment vehicles.
âYou don’t want to put all of your short- or medium-term money into one single action or one alternative,â says Adam.
After all the uncertainties in the economy during the pandemic, investors must remember the need to stay the course. You invest for the future, not just by following the constant fluctuations of the market.
âYou really have to stay focused on your goal and not get distracted by what the market is doing today or what’s on your statement today, because if you do that you are stepping away from that path and you don’t want to do it. , adds Adam.
2. Pay off high cost debt
Earning a return does not necessarily mean “investing” in the traditional sense. It can also involve getting rid of high cost debt that could drag you down. If you carry a balance on a credit card with an interest rate of 15% month over month, you’ll pay more than the interest you could earn on a CD or any other traditional savings product. It’s much better to use your money to bring that bill down to zero than to put it in a low-risk option that might pay 2% interest per year.
âMortgages and a car note may be okay, but you should be paying anything that has a double-digit interest rate,â says Bill Hammer Jr., president of New York-based Hammer Wealth Group.
Paying off credit card debt also protects you against rising interest rates in the future. And once the debt is paid off, it will be easier to set aside money on a regular basis and build up savings.
âPaying off debt is one of the only ways to get a guaranteed risk-free return,â says Hammer.
3. Peer-to-peer loan
While you want to pay off your debt, others like you might need to borrow money. Peer-to-peer lending, often referred to as âP2P lending,â is a creative option if you’re willing to take a little risk for a higher reward, says Foss of Empyrion. Consider Prosper, which allows you to make loans to random strangers and earn a good annual return. Prosper’s data shows that individual investors get average annual returns of 5.3%.
You can lend to borrowers in different risk categories based on their credit rating. Just as a bank may charge a higher interest rate for those with lower credit scores, you get a higher interest rate if you agree to lend to people with less than perfect credit.
Foss says it’s a less risky option than the stock market. She recommends sticking to borrowers who have AAA ratings.
âI wouldn’t put all your money here, but it could work well as part of a portfolio with dividend-paying stocks and a short-term corporate bond fund,â Foss said.
4. Bond funds
Another alternative to investing in CDs is short-term bond funds. The funds have similar terms such as 1 year and 3 year maturity dates, and they hold bonds in everything from foreign countries to utilities to corporations. Yields can also be quite high. For example, Vanguard’s Short-Term Bond Index Fund (VBISX), which allocates money between corporate and US government bonds, has a three-year annualized return of 3.28%, as of October 25. 2021.
Another option could be an international bond fund. Many of these funds hold bonds of creditworthy countries rated AAA. There are also emerging market bond funds, although these carry greater risk. To get started, read Bankrate’s guide on how to invest in bonds to learn about the wide range of options.
CD vs Money Market vs Roth IRA
Trying to choose between a CD, a money market account, and a Roth IRA? The correct answer depends on how you plan to use the money you set aside.
If you’re looking for a place to park your emergency funds, for example, you’re probably better off putting them in a money market account, Adam says. This way you can withdraw it as soon as you need it without worrying about a penalty. You will also earn a little, but nothing to write home about. In the current climate, the best money market rates are around 0.5%.
A CD can be a good place for short-term cash that you plan to use in a year for an expense like buying a car or a house. But this is not a good place for long term retirement funds. Instead, these types of savings should go into a retirement account, such as a Roth IRA that allows for tax-free retirement withdrawals, because contributions are made with after-tax dollars. And if retirement is still a long way off for you, it’s essential to think about the best long-term investments for your strategy.
Are CDs Worth It?
Right now, you’ll be hard pressed to find an interest rate on a standard CD that will justify freezing your funds for an extended period of time. While traditional CDs might not be worth the money in today’s market, you might want to explore other options for CDs. For example, Ally Bank offers a CD that gives you the option to request a rate increase that adjusts to the bank’s updated rate (once for the two-year CD and twice for the four-year product) .
A number of banks including Marcus by Goldman Sachs offer a CD that allows you to withdraw your funds without paying a penalty. Be sure to compare Bankrate’s best investments to determine which vehicles are on the right track for your growth needs.
Are CDs a Good Retirement Investment?
“If you (are) a younger person, investing for retirement or something that is a long term investment that you want, you shouldn’t be in CDs as they are short term investments in my opinion. , with low yields. âAdam adds. âYou can’t fund your retirement on two counts, regardless of the performance. You have to get more growth.
To find that growth, Elliot Pepper, CPA, CFP, MST, financial planner and tax manager at Northbrook Financial, based in Maryland, recommends target date funds.
âMany large institutions offer target date funds, which are very popular in 401 (k) or retirement accounts because they essentially offer a transition path from riskier investments to more conservative fixed income investments based on of the fund’s target date, “says Pepper.
Once that target date arrives and you retire, CDs could be a good addition to your portfolio. However, it’s important to note that you might get lucky and live even longer than you expected. In this case, you might need more than the income from the CDs.
Are CDs zero-rated?
A CD will earn you interest, but you will also have to pay the government. Just like the money you would put in a savings or money market account, money saved on a CD is taxable. This can drastically reduce your income, especially if you don’t save that much money up front.
If you have CD IRAs, you won’t pay contribution taxes or interest until you withdraw the money in retirement. If you open Roth IRAs, your distributions at retirement would be tax exempt.
If you’re really concerned about your tax situation, you might want to look to an alternative – like a municipal bond – to avoid the tax problem altogether.
Best returns for short and long term funds
A CD is only an option if you are looking for a place to store your short-term funds. There are a variety of alternative options out there, especially if you are looking for a higher rate of return and are willing to compromise with a higher risk. Besides municipal bonds and short-term bond funds, you might get a higher return by investing in a mutual fund. Depending on how you invest your money, you could end up with a double-digit return.
For your long term financing needs, you will need to look beyond CDs.
âCDs aren’t always the right choice, especially if you won’t need the funds for several years or more,â says David Sterman, CFP, president and CEO of New York-based Huguenot Financial Planning. “Funds that focus on longer-term bonds will always offer better returns than CDs.”
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