Risk appetite is significant in determining the kind of investment you want to get involved in. Some people do not have the risk tolerance for high volatility markets like the stock markets or exchange-traded funds and would rather opt for safer, low-risk investments. That being said, the risk-return tradeoff that investors face is between high risk with high potential reward and low risk with low potential reward. This means that the lower you want your risk to be, the lower the potential reward you will gain.
A certificate of deposit (CD) is an investment option that offers one of the lowest risks to your capital. It involves depositing a certain amount of money into a bank for a fixed timeframe, after which the original capital and accrued interest are paid back to the investor. Traditionally, the higher the amount deposited and the longer it is deposited, the higher the returns will be.
Banks that offer this certificate as a product have their own uniquely determined return rates, terms of service, and penalties that apply for taking out the investment before the fixed time. Almost all banks offer a CD investment option.
To avoid being penalized for early withdrawal, it’s important to decide in the original agreement the length of time that is feasible for you as an investor to keep the money locked in the deposit. When money is locked in the deposit, and the rate is fixed, it’s simpler to know the expected returns at the end of the term.
But as much as that is a guarantee of profit, it inadvertently means that even if the rates go up after your deposit agreement, you cannot profit from the increase. Generally, return rates on CD investments are higher than ordinarily saving money in the bank or investing in other money market products. But all the same, the interest rates are pretty low.
Part of the contributing factor to the low risk is that the federal government insures certificates of deposit through an independent agency. So even if the banks become bankrupt and are forced to close down, those deposits will not end up as losses for the investor.
The nature of this type of investment allows it to be more favored by people trying to build wealth for when they are no longer working, or as a plan to leave something substantial for when their kids grow up, to help them get started on their own financial journey.
Maximum profitability from this investment comes when there is no short-term need for the money invested, and it is allowed to spend a considerable amount of years accumulating interest. Following the idea of this scenario, it would make sense to throw more spare funds into other types of CD whose rates have become higher over time than previously fixed ones. This way, even with low risk, one can have amazing rewards in the long term.