Throughout my career, I’ve frequently encountered clients asking the elusive question: “Isn’t there somewhere I can get a 5% return with no risk?” Unfortunately, for the longest time, the answer had always been a disappointing “no.” With persistently low interest rates, the opportunity for substantial yields from conservative investments seemed out of reach. However, as the Federal Reserve has taken measures to combat inflation through interest rate hikes, the landscape has shifted. We now find ourselves in a position where risk-free investments like treasuries and low-risk CDs can offer remarkably attractive yields.
At Innova Wealth Partners, we have been taking advantage of current interest rates by incorporating short-term CDs into our clients’ portfolios. Using laddering techniques and other tailored strategies, we’ve worked to optimize the benefits of CDs based on each client’s individual needs.
In this month’s blog, we’ll dive into the world of CDs and explore important factors to consider before investing.
What’s a CD?
Certificates of Deposit are financial instruments issued by banks. Like other fixed income products, investing in a CD involves lending your money with the expectation of receiving interest payments and the return of your initial investment at the CD’s maturity. Let’s explore some key points to consider when evaluating CDs as an investment option.
The term refers to the duration for which your money will be invested in the CD. CD terms can vary from a few months to several years. Currently, interest rates are inverted, which means shorter-term CDs tend to offer higher rates than longer-termed CDs. This is not the norm, but it is the reason why we are able to take advantage of high yields without keeping our money illiquid for years. Speaking of illiquidity, it’s important to note that when you purchase a CD from a bank, your money is locked up until the CD matures. However, if you buy CDs through a brokerage account, they become tradable securities, providing liquidity on a daily basis. Keep in mind that the price of tradable CDs will fluctuate with interest rate changes (as rates rise, fixed income prices fall and vice versa). Nevertheless, if you hold the CD until maturity, you will receive your entire initial investment back plus interest.
Always remember that yield is quoted in annual terms or Annual Percentage Yield (APY). It’s crucial to understand that a 3-month CD with a quoted yield of 5% does not mean you will receive 5% of your initial investment. In the case of a 3-month CD, you would receive one quarter of the quoted 5% in dollar terms. Since 3 months is one quarter of a year, you should receive one quarter of 5%, or 1.25%. This yield can be paid in a few different ways like; monthly, quarterly, and at maturity.
Like any investment, CDs come with their own set of risks. One such risk is default risk. While investing in CDs, it’s important to consider the stability of the bank issuing the CD. In the unfortunate event that the bank goes out of business, there is a risk of losing your initial investment. However, there is a safety net in the form of the FDIC (Federal Deposit Insurance Corporation). The government has implemented FDIC insurance, which guarantees to reimburse you for up to $250,000 of your initial investment in case of a bank failure. This aspect becomes even more advantageous when purchasing CDs through a brokerage account. Within the same account, you can diversify your CD purchases across multiple banks, allowing you to enjoy the FDIC insurance limit of $250,000 for each CD.
Minimum Investment Requirement
It’s worth noting that some CDs have a minimum investment requirement. The bank or financial institution may require a specific minimum amount to be invested in the CD. Be sure to consider this requirement when evaluating your options and determining if it aligns with your investment goals.
Ideal for Near-Term Goals and Idle Cash
Aside from their potential for attractive yields and low risk, CDs serve as an excellent option for parking money that may be needed for near-term goals. For example, if you’re saving for a down payment on a house or planning a dream vacation in the next year or two, investing in a CD can provide a secure way to grow your funds while ensuring they are readily available when needed. Furthermore, if you have cash sitting on the sidelines, waiting to be deployed for future opportunities, CDs can offer a practical solution to earn a modest return until the funds are required elsewhere.
Investing in CDs can be a compelling option for those seeking attractive yields with relatively low risk. However, it’s essential to carefully evaluate the term, yield, default risk, any minimum investment requirements, and consider their suitability for your near and long-term goals. If investing in CDs sounds like a viable option for you, please reach out to an advisor at Innova Wealth Partners!
INNOVA is a SEC registered investment adviser. Information presented is for educational purposes only intended for a broad audience. INNOVA is not giving tax, legal or accounting advice, consult a professional tax or legal representative if needed. The opinions expressed herein are those of the firm and are subject to change without notice. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Any opinions, projections, or forward-looking statements expressed herein are solely those of author, may differ from the views or opinions expressed by other areas of the firm, and are only for general informational purposes as of the date indicated. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.