The Unsung Hero of the Business Savings Plan
As a business owner, you have a number of options in which to invest your retained earnings. One example is the certificate of deposit, or CD.
Befitting its name, the CD is a financial instrument that allows you to make a deposit for a fixed period of time (for example, 24 months) and draw interest at a greater rate than the typical savings account.
Why Should You Use Certificates of Deposit?
First, the Federal Deposit Insurance Corporation (FDIC) insures CDs for up to a maximum value of $250,000, meaning that CDs for either $250,000 or less are close to being risk-free.
Second, as mentioned, CDs tend to earn higher interest rates than savings accounts, though the exact interest rates are set based on factors such as:
- The size of the deposit
- The length of the deposit
- The prevailing interest rates at the time of the deposit
Finally, the CD is similar to a savings account in that you can withdraw the deposited cash at any time, so long as you’re prepared to face the penalties. These range from withdrawal charges to a partial loss of the interest earned.
How to Use Certificates of Deposit
The CD is the perfect financial instrument if you’re interested in protecting the value of your savings but are unsatisfied with the small sums of interest paid out on savings accounts.
For example, if you plan to purchase a large equipment or technology upgrade in the future, then investing your current savings into CDs is a method that puts the funds to greater use during the waiting period without risk.
While you could potentially earn more by investing in riskier assets such as stocks or bonds, this leaves the funds vulnerable to the market and can also result in disruptive losses.
The CD is also useful as a means of saving cash in case of unexpected cash flow emergencies. Prevailing wisdom suggests that businesses should have sufficient cash and cash equivalents to cover between 3 to 6 months of their operating expenses.
However, this is can be problematic if the cash and cash equivalents are sitting in savings accounts when much more lucrative options are available. It might be better to have an operating account with sufficient cash and cash equivalents to cover 1 month’s operating expenses, with between 3 to 6 months’ operating expenses deposited in CDs.
This way, you can still cover unexpected emergencies while putting your savings to excellent use.