My first investment: Savings and CDs

It’s a financial jungle out there, where to start for a first investment?

Putting money into a savings account should be your first step to investing. Building up your savings from your monthly paycheck (say 15%) should be considered as your first investment since your savings account will generate annual interests income (between 0.5% and 2%).

Opening a savings account is very simple and straightforward, just go to your local bank to open one, and transfer money automatically from your checking account to your savings account every month. The amount of money to transfer is at your own discretion but should be at least 10% of your monthly paycheck.

Savings accounts have typically low interest rates, so if you want your first investment to generate more interests income, you will need to put your money into more aggressive financial accounts, such as “Certificate of Deposit” aka CDs.

What Is a Certificate of Deposit?

A CD is a savings account that you can open for a set amount of time with a fixed interest rate. CDs usually offer higher interest rates than regular savings accounts, but they come with more rules too. They can only be opened for a minimum amount of money (say $1,000) and once you open (aka buy) a CD, you can’t withdraw money from the account without facing penalties. This is one of the biggest differences between a CD and a regular savings account, the money isn’t easily available (aka liquid) for withdrawal. The money goes into the CD and stays there for the set amount of time. If you take $5,000 and put it in a CD for 18 months at 1.25% interest rate, you can’t take money out of the CD for the next 18 months without incurring an interest penalty.

Most financial institutions offer CD terms in multiples of six months. So you can open one for six months, 12 months, 18 months, etc. the longer the term length, the higher the interest rate. CDs are very safe, like other savings accounts they are insured by the FDIC.

Types of CDs

There is more than one type of CDs, here they are:

  • Small CDs: CDs of less than $100,000
  • Large or Jumbo CDs: CDs for more than $100,000.
  • IRA CDs: Instead of transferring money to a CD from your checking account, you open one using funds from your IRA.
  • Bump-up CDs: These allow you to request a higher rate if your bank increases its annual percentage rate (APR). Generally you’re allowed to ask for only one interest rate bump with these accounts.
  • Step-up CDs: With this type of CD, your account receives periodic rate increases, where the APR on the CD automatically goes up.

Pros and Cons

CDs are a safe place to keep your money as far as bank accounts go. Pros include:

  • High interest rates
  • FDIC insured accounts
  • A low-risk option for money

CDs come with low risk, but that means they don’t come with high returns. If you’re interested in growing your money substantially, you should look into investing in the stock market. Cons of a CD are:

  • Set term lengths prevent you from accessing the money freely
  • Penalties for early withdrawal
  • Not good for high return rates

Conclusion

CDs are great options for many different financial situations and people. They are great for building capital to fund later bigger investment (house, retirement fund, life savings). Once you need more interests income or a better return on your money, you can transfer the funds in your CDs into more aggressive financial instruments like equity shares and investment grade bonds.

CDs can also be a way for parents (or grandparents!) to introduce their child to saving money and general money management. Opening a CD with your child can show them the power of interest over time, as well as impress upon them the need to have savings for the future.