Certificates of Deposit (CDs) should not be confused with CDs which we used to buy to listen to music, update computer software or play games. Kids these days will never understand the psychological and emotional damage of finding a scratch or dent on the shiny side of those discs! No, what we are discussing here are the products that banks offer to the public and in exchange for locking your money with them, they will offer you interest on your money.
What are CDs?
Remember when we talked about Bank accounts?
CDs are just another way the bank uses to convince you to keep your money with them so they can lend it out and make more money. Instead of an account you can withdraw from, CDs are locked for a specific period (3 months, 9 months, 1 year, 3 years, 30 years, etc.).
The bank realizes that parting with your money can be painful, and is willing to pay you money in exchange for keeping your money with them. The interest rates offered on CDs closely track the national interest rate prevailing at the time you place your money. For better or worse, the price is fixed.
How does this increase my passive income?
You’re probably wondering why this isn’t under He buys category. Since there is a time limit on the interest you receive, you are in effect borrowing the income for the time being since there is an expiration date for the income. There are two ways a CD can increase your passive income.
The most obvious way is to increase income from interest payments. If you have cash in a savings account and don’t plan to withdraw it, not even in an emergency, it may be worth digging around to find a CD in which you can store your money and get paid for it.
Another option is to achieve a specific, time-bound goal. Suppose you want to invest a lump sum in an income-producing asset. Money is tight, but you managed to save some money for a chance. Instead of keeping it in a checking/savings account where you might be tempted to use it for something else, putting it in a CD will not only earn you extra income, but it will also prevent you from jeopardizing your original plan.
Then, when the money is distributed to you, you will not only have more money to work with than you did before (despite a downturn or recession in the economic landscape), without taking inflation into account, but you will be ready and able to pay for the purchase of another product To increase your income!
Why do I want this passive income?
Let’s take 2022 as an example. US interest rates are rising and so is inflation. At the same time, the value of traditional investments, such as stocks/bonds, is declining. Instead of trying to time the market bottom, it may make more sense to put your money in an FDIC-insured CD that has very little chance of its value declining. Inflation, i.e. the rise in commodity prices relative to the local currency, also erodes the purchasing power of stagnant money.
A person who is interested in preserving his original amount of money may consider investing in short-term CDs. When the CD matures (that is, when the bank returns your money), you can reevaluate the market to see if it would be a good idea to reinvest in another CD at higher rates if one is available. This way you get the following benefits:
- Your money is available to you within months
- You are locked to benefit from the prevailing interest rate
- You have a low chance of losing any money
While it does require some research and effort to purchase a CD, you can rest assured that your money is working for you while you wait to take advantage of future opportunities or goals (down payment on a house, future expenses, etc.).
Risks and considerations
You should be very careful before linking your money with a bank. You may want to make sure you have adequate means to pay for your expenses and an emergency fund in case something devastating happens while your capital is tied up.
You may also want to make sure that the bank or credit union you are looking at has no hidden fees, has been in business for a number of years, and has a digital platform that enables you to track your money and get a return on your capital. You don’t want to be scammed by some Fake bank promising high returns You will likely only get one payment and then won’t be able to get any of your money back.
Fixing interest rates has risks too! If prices fall, you have to worry about reinvestment risk. For example, if you were earning 5% a year ago and the rates at the end of the term are 3%, you may have to take on more risk to get a 5% return again.
In the reverse scenario, if rates rose and you locked in a lower rate, you would be stuck earning, say, 3%, while CD rates rose to 5% over the term of the deposit, and you missed out on earning more interest. This last example may be more of an opportunity cost than a risk, but regardless, you need to align your investment with your goals and be aware of what you might be risking. There are a number of Strategies To invest in fixed income products, be sure to minimize your risks by knowing which ones meet your needs!