CDs

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Of late my inbox has filled with suggestions from my bank that I transfer some of my savings account into certificates of deposit (CDs).  The e-mails from my bank correctly point out that, because the rates on conventional savings accounts are lower than the rate of inflation, I am actually losing purchasing power on the money I leave there.  They suggest that the purchase of CDs paying a higher rate can remedy my situation. Some readers and friends have received similar messages and have asked me how to respond.  The short answer is that the banks could have a very good idea. But as I have pointed out often in these posts, it all depends on your personal needs and plans.

The decision must involve more than just comparative interest rates.  Because CDs involve the commitment of a sum of money for a set period of time, the first question to ask yourself before buying one is: “How much money do I need in ready cash that I can get at a moment’s notice?”  That amount should remain in your savings account. The number, of course, will depend on your personal circumstances.  Aim to hold between three and six months worth of expenses in ready savings to deal with emergencies –– most especially if you lose your job. Where you fall in that three- to six-month range depends largely on your answers to two questions:

1. If you have a spouse or partner, do they have a paying job? If they do, you probably need less. The three months of expenses should cover emergencies, such as having to replace a roof, or at least give you a good start on covering such expenses.  If you lose your job, this other income can cushion your household from that loss, reducing your need for ready cash.
2. Is your job secure? If you are a civil servant or belong to a strong union, you are less likely to suffer a job loss than, say, if you work on Wall Street or in industrial employment, where slowdowns can lead quickly to layoffs.

The other consideration on a buying a CD depends on your personal plans.  You may have built up your savings account to make an investment move or to make a large purchase of a car, for instance, or a new kitchen or even a house. If you want to do that in the very near future, then the CD will not suit you, because most CDs require that you tie up the money for several months.  But if you expect you won’t need the money for at least a year, then a CD can earn you more and you can accumulate savings at a faster rate.

There are all sorts of CDs, and they have all sorts of provisions.  Once you have decided you want to buy, you will need to consider these and understand how banks quote the rates of return on various CDs.   This earlier post outlines those options.