The Price of Commitment: Higher Interest

With certificates of deposit, it isn't the price you pay for the commitment, it's the price you earn for it.

In 1987, a self-help book entitled Men Who Can't Love coined the not-so-catchy term commitmentphobia. Commitmentphobics often miss out on potentially rewarding personal relationships out of a fear of making bad decisions. And wouldn't you know it-there are some financial downsides to avoiding commitment, as well.

The pay-off of CDs

Interest rates paid on certificates of deposit (CDs) are much higher than those paid on traditional savings accounts, and sometimes even on money market accounts. There's a catch, however: You must leave your money on deposit for a fixed time period. The length of time varies, but the minimum is usually three months. If you can handle that three-month commitment, you'll increase your interest income significantly.

You can open a CD with a brick-and-mortar bank or an online one. Either way, the deposit is insured by the FDIC for up to $100,000. CD rates vary by the duration of the deposit, and longer terms usually pay slightly more. Once you establish a CD, you're guaranteed to earn that rate of interest for the specified time period. Some CDs allow you to add money to your investment during the locked period, but you can't make withdrawals without penalty. As with a regular savings account, the interest payments are automatically deposited to the account at month's end. You may have the option to receive the interest payments by check, as well. When the CD matures, you can withdraw your money or roll it into a new one at the then-current interest rate.

Drawback of time deposits

Exact penalties for early withdrawal are specific to each bank. They usually aren't huge, but you should know what they are before you commit. It would definitely cost you the interest, and sometimes a bit of principal. Avoid these costs by keeping enough cash on hand, either in your checking account or traditional savings account, to get you by until your CD matures. Eventually, you might establish a portfolio of CDs with staggered maturities to minimize your liquidity risk.

When choosing CD maturities, your interest rate will be fixed for that time, regardless of what happens in the market. This can work for or against you. If you lock in 5 percent for three years and market rates drop, you'll be earning more than the market is paying. This is great-that is, until renewal time, when you must lock in the lower interest. Rates can also go up while your CD is locked, leaving you earning less than the market is paying. Since rates will change significantly over time, avoid CDs with maturities of longer than five years.

If you're a commitmentphobic, the experts might advise that you start with small doses of permanence-and a three-month CD investment could be just what the doctor ordered.