Most people don’t really consider these options as “investments” in the same way they think of stocks and bonds, but they really do the same thing. You invest a certain amount and receive interest on your investment.
We all know what a savings account is. You put some money into your account, and the bank pays you a tiny bit of interest.
There are several nice features to a savings account. For one, you have immediate access to the funds in the account, either by visiting the branch, using an ATM, or making an online transfer. You don’t have to call a broker and wait a few days for the money to arrive. Second, you don’t have to worry about your investment losing money. Unlike stocks and bonds, the value of what you have in savings doesn’t fluctuate with the financial markets. Finally, funds in a bank account are federally insured up to $250,000 per person per bank/credit union. So, if you have a joint savings account (two people’s names are on the account) it is actually insured up to $500,000.
Of course the disadvantage to a savings account is that interest rates are very low. At a typical bank branch you might be able to earn 0.1%. At an online bank such as ING Direct or Ally, you’ll get closer to 1%. So, you definitely wouldn’t want to use a savings account for your retirement fund, but they are certainly the best option for storing your emergency fund, house savings fund, etc.
Certificates of Deposit
These are similar to a savings account with the exception that CDs have a specific maturity date, and you must wait until that date to receive your funds. Maturities can range anywhere from 7 days to 10 years. Again, you don’t have to worry about losing your money since these are federally insured accounts. Since your money locked limits until maturity, CDs typically pay higher interest rates than a savings account. Again, the rates are still lower than what you can earn on stocks or bonds (the average 3-year CD special at a bank will run close to 1%, even at an online bank). Make sure to check out smaller local banks and credit unions, as they typically offer higher rates than the large national banks.
CDs are good for the conservative investor whose primary investment goal is capital preservation. They don’t want to risk losing their money and are willing to accept a lower return as a result. CDs are a good investment option for those in retirement.
Some banks require you to maintain a checking account with their bank to get the highest CD rates, and there can also be minimum investment requirements as well. Always be sure to read the fine print.