Zero Coupon CDs: What Are zero coupon certificate of deposits?
CDs are great investment opportunities for investors. Investors have a great amount of flexibility in investment types that are safe. There are advantages and disadvantages in any investment type. Investors who are looking for a good long-term investment may find Zero coupon CDs very interesting. They offer a greater payout than traditional CDs. Investors who are interested in a huge payout should consider investing their money in Zero coupon CDs.
How do Zero Coupon Certificate of Deposit CDs Work?
Zero coupon CDs are investment options that do not pay interest to investors until the maturity date. The interest rates of these CDs are lower than that of traditional CDs, but investors purchase these CDs at below value prices. Investors are expected to pay taxes on these CDs even though they do not receive any actual payments on the investment until maturity. Zero Coupon CDs may have lower returns than other types of CDs.
Advantages of Zero Coupon Certificate of Deposit CDs
- These CDs are purchased at deeply discounted prices. Investors can receive large CDs for a small amount of money. For example, investors may purchase $100,000 CDs for $50,000. Purchasing CDs at discounted prices help investors to make a substantial amount of money in the end. The fact that these investment types have lower interest rates is not a problem since investors do not pay the full value on the investment.
- The rates are locked in until the maturity date. In the event interest rates lower, investors get the benefit for the fixed interest rate for the remainder of the terms. Investors’ assets are protected if the current interest rates continue to decline. Investors can be confident that their principle and interest are safe.
- The investment pays out at a higher face value. Since investors do not pay the full price for Zero coupon CDs, they receive the benefit of gaining CDs with higher value at maturity—especially CDs with long terms. Some investors may double their original investment and earn hefty interest rates as well. This is a good investment for investors who want to buy a home or pay for their child’s college tuition. This money can sit and accrue interest and principle that investors gain at maturity.
- The original low rates may not reflect current interest rates. Interest rates have declined over the past few years. If the rates continue to decline, investors who invest in Zero coupon CDs do not lose interest. Since the rates are fixed, lower rates do not affect investors’ money.
Disadvantages of Zero Coupon Certificate of Deposit CD
- Interest is paid at maturity for Zero coupon CDs. This is not an investment type for those who want to earn money now. The terms on Zero coupon CDs may vary. Investors may have the CDs for many years before they receive any money. For example, investors who own 10 year Zero coupon CDs may not get principle and interest until maturity. Investors may have to wait a long time to receive the benefits of their investments.
- Investors pay taxes on the investment. Investors may pay hefty sums of money during tax time. Many Zero coupon CDs are $50,000 or more. This kind of money can mean that the investors pay high taxes during tax season. Paying taxes on such a large sum of money that they cannot spend may be hard for many investors. This is something to consider before purchasing Zero coupon CDs.
- Some Zero coupon CDs are callable. Investors must make sure that their CDs are not callable. This feature entitles investors to a fixed rate until the CDs are callable. Callable CDs are investment types that give the issuers the right to lower interest rates if the market rates decrease. This can be a potential disaster for investors. The fixed rate that they thought that they had can be taken away from them after the call date for the CDs.
- They offer no steady income to investors. Investors earn a great deal of money at the maturity of their CDs, but there is no income until the maturity date. Investors do not get their principle or interest until the maturity.
Investors should not invest their money in zero coupon CDs until the rates are high. This strategy allows them to create a higher payment on their investment. Purchasing zero coupon CDs when rates are low will hurt investors if rates rise over the terms of their CDs. As long as investors buy these CDs wisely, they can benefit from the investment in the end.