Despite their low interest rates, there are a few good and not-so-obvious reasons why SMBs should be investing in Certificates of Deposit.
Certificates of Deposit (CDs) are a well-known method of saving in the financial world. But with current interest rates for CDs so low, why would small businesses want to invest in them?
Here are a few of the reasons why small businesses are making use of CDs.
When a business owner applies for a corporate credit card, banks will ask for collateral that does not include financials as part of the review process. Opening up a Certificate of Deposit is one possible way to demonstrate the collateral needed to satisfy the banks.
With this collateral in place, small businesses owners are better able to gain credit card approval and the ability to start taking advantage of the benefits of business credit cards. In short, CDs can be a simple way to help bolster an SMB’s overall financial picture and help pave the way to more opportunities.
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Ease of Setup and Use
One of the advantages of Certificates of Deposit is that unlike some other forms of investments, CDs are inherently simple to understand and set up with the lending institution. In addition, they usually require only a relatively small minimum startup amount; minimum opening amounts can be as low as $1,000 or even $500, and term lengths are usually set somewhere between 3 months to 5 years.
Once a Certificate of Deposit is set up, it’s generally simply left alone to gain interest for the duration of the term length. As the CD approaches maturation, the bank notifies the SMB owner, who will then able to transfer out the funds, change the over money to a different type of CD, or simply allow the bank to put the funds into a CD with the same term length as before. The non-fussy nature of CDs makes them a good choice for today’s business owners who are strapped for time and don’t want to bother with complicated investments.
Low-risk Investment Option
CDs may not be known for having a high interest rate, but to counteract this, their relatively small rate of return is consistent. Unlike other, higher-risk types of investments such as stocks, Certificates of Deposit are essentially as risk-free as a savings account; their rate of return is virtually guaranteed. When investing in CDs, a small business won’t be affected by sharply falling interest rates, giving peace of mind to the busy business owner. And up to $250,000 invested in CDs is eligible to be insured by the Federal Deposit Insurance Corporation, making the security of this option even greater.
In return for the slightly higher interest rate than regular savings accounts, CDs function through “locking in” an investment, and there will usually be penalty fees for early withdrawal. Because of this, small business owners who use CDs take into account how long their investment will be basically inaccessible. Generally, the shortest terms available without withdrawal penalties are in the 3-6 month range, but the longer money is kept in a CD, the greater the investment returns will be.
These differences can be significant; while some banks currently offer a mere .20% Annual Percentage Yield for investments under $100,000 for a 3-month term, there are institutions where the APY shoots to above 2.0% for a 60-month term. Certificates of Deposit, then, are best used by business owners who strategize and plan out the financial goals of their company and choose the terms that make the most sense for their business’ needs.
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“Laddering” is a method that businesses use to help grow their Certificate of Deposit investments and help maximize their returns. To make use of this technique, a business owner would, for example, stagger investments of equal amounts of funds into several different CDs with different term lengths – perhaps starting five different CDs with term lengths ranging from one year to five years, for instance.
Once the CD with the smallest time frame comes to maturation with its accrued interest, that total amount would be taken and invested again in a five-year term CD, and so on in rotation. Using this method has many benefits; by having a rotating queue of CDs with smaller investment amounts rather than one CD with a large amount, businesses will have access to penalty-free cash from at least a portion of the CDs at much more frequent intervals, as they will mature in cycles.
One can then choose to take the cash and use it elsewhere for the business, or re-invest in another CD at a possibly better interest rate. By utilizing simple methods like these to manage funds in CDs, businesses are able to see returns beyond what might appear at first glance.
Despite their lack of high interest rates, CDs are a good, basic shorter-term investment tool for business owners and can be a solid choice to add into a business financial portfolio. They’re low-risk, can stand in as collateral, and with a little careful planning, investors can reap solid benefits through this financial product.