Certificates of Deposit (CDs)/Money Market Funds

A certificate of deposit (CDs) is nothing more than a guarantee to a bank that you’ll leave a certain amount of money deposited at the bank for a certain amount of time. Banks use the money to operate, to invest and to make loans. In exchange for agreeing to leave your money deposited at the bank, the bank will pay you interest.

Certificates of Deposit can be a good way to invest money without having the associated risk of the stock market or purchasing bonds. Also, CDs are easily handled through your bank without having to go through a broker or brokerage firm – which saves you money on brokerage fees. Although, there are certificates of deposits sold by brokers. A broker may be useful if you choose to sell your CD before it has matured.

CDs mature at different time periods assigned by the bank. You can buy short-term certificates of deposit for as little as six months or long term CDs for as long as five years.

The interest rate assigned to a CD by a bank can vary. Most CDs come with a fixed interest rate for a fixed time. But banks can vary the interest rate offers. Some CDs may carry a variable interest rate or a contingent interest rate. Variable interest rates may be tied to certain indicators in the financial market such as the prime rate. Contingent interest rates may be contingent on a financial indicator such as the stock market or the outcome of some other financial event.

One major benefit of buying a certificate of deposit from a bank is the insurance from the FDIC. Deposits in banking institutions are normally protected up to $100,000 by the FDIC. But recently the FDIC upped that amount to $250,000 until the end of December 31, 2013. This means there’s even less risk in investing your money in a CD.

If you purchase a certificate of deposit, then you will not have access to that money until the CD matures – unless you’re willing to pay penalties. And sometimes banks do not allow access to the money at all. However, money market accounts are very similar to certificates of deposit, but these accounts allow a certain number of transactions per month – as a checking or savings account. But because you agree to keep a certain amount of money in the account, the bank is willing to pay a higher rate of interest.

Then there are money market funds. These are also a very low risk investment option. Money market funds are measured by a net-asset-value (NAV) of $1. This means the investments maintain a consistent value of $1 after all interest has been paid. Money market funds are very short-term investments and therefore are seen as having little risk. Only on rare occasion has a money market fund dipped below $1.

Just like certificates of deposits, banks use money market funds to invest. But these investments are very short term – less than 13 months. The government regulates that the average time of maturity in a bank’s portfolio cannot be greater than 90 days.

Because these bonds are short-term and there is little risk, they also yield a low return on investment. Money market funds usually yield a higher interest rate than a standard bank account but maybe not as much as a CD.

You should always research the terms and conditions of a certificate of deposit or money market fund to determine which is best for you and what terms you are most comfortable accepting.