Other Factors to Consider when Deciding on the CD Terms
- If money supply decreases and you will be enticed to place your money for a longer CD term at a higher interest rate, you may also have to consider any major purchases you are planning to buy in the future. Sellers will also be offering their commodities at lower prices to increase the buying power of your money.
You are in fact, being enticed to put your money in their business instead of keeping it intact in a bank account. In a year’s time, the money circulating in the business economy may increase and the price of the commodity you plan to purchase will also increase. Hence, if for example you locked-in your $ 1,000 in a 1-year CD at an increased APY of 3% instead of going ahead with your plans to renovate your bathroom. The money you placed as a one-year CD was set aside for the purpose of purchasing a vanity-and-sink-fixture with a current price of $ 990.00. This decision however, would mean that you did not take into consideration the present buying power of your money.
The time value of money for you certificate of deposit upon maturity will be $ 1,030, but it is also possible that by that time, the price of the vanity-and-sink fixture will increase your home's selling price, let’s say by $60. Hence, if you will buy it at its new price of $1,050. you would have incurred an opportunity cost of $30. The latter was arrived at, by deducting the $30 interest you earned from the CD against the price increment of $60.
- In scouting for a bank where you can place your money in CDs, you should also checkout the bank’s CD early withdrawal penalty. Again, you should consider your future financial goals and anticipated emergency needs. Federal banking laws stipulate only a minimum amount of 7 days penalty interest for a CD that is pre-terminated before its maturity.
- However, since there is no cap for the maximum, banks differ with their pre-termination penalties. Most banks usually impose a penalty of 3-month interests for CDs with placement terms ranging from 2 months to 18 months. Some banking institutions may even charge as much as 6 months interests and this will result to a time value of money for certificate of deposit that will suffer from a large reduction of the principal amount.
In regards to the explanations about the time value of money for certificates of deposit included in this article, all pertain to traditional CDs. In as much as financial institutions are currently building up their own resources without having to offer high yields, there are non-traditional CDs you can inquire into. These are not as high-yielding as the traditional CD but they offer more flexibility by dispensing with the rigid CD early withdrawal penalty.