What Is a Certificate of Deposit CD and What Can It Do for You?

Because of the fixed maturity date, you will likely have to pay the penalty if you need the funds before the maturity date. Additionally, Certificates of Deposit may offer lower returns than other investments, meaning you might have missed out on more enormous profits elsewhere. Finally, if inflation increases faster than the interest rate on your CD, your savings could end up being worth less over time. Some savers like CDs because of the safety they provide, as well as the fact that they are perfectly predictable. On the other hand, CDs generally promise a very modest rate of return, compared to riskier investments like stocks and bonds. If the interest rate offered is below the current inflation rate, then investors in CDs will actually lose money on their investment when it’s measured on an inflation-adjusted basis.

On the other hand, CDs tie up your funds for a set period, and you can’t easily access them if you need to. As mentioned before, if for some reason you pull your funds from a CD before it matures, you’ll likely incur penalties. The penalty for tapping these funds early depends on the length of your CD term.

Finally, they tend to have low minimums, allowing anyone to start investing with little money upfront. Certificates of Deposit (CDs) may be a worthwhile investment for some people, depending on their financial goals and needs. However, comparing rates between different banks and institutions is crucial to ensure you get the best deal.

Beyond the Fed’s action, however, the situation of each financial institution is an additional determinant of how much interest it is willing to pay on specific CDs. For instance, if a bank’s lending business is booming and an increasing amount in deposits is needed to fund those loans, then the bank may be more aggressive in trying to attract deposit customers. By contrast, an exceptionally large bank with more than sufficient deposit reserves may be less interested in growing its CD portfolio and therefore offer paltry certificate rates. Investing in CDs can be a good choice for people who want to keep their savings safe and secure. CDs offer FDIC insurance, meaning you can get your money back even if the bank fails. Furthermore, they can provide a predictable interest rate and help diversify a portfolio.

What Is a Certificate of Deposit (CD) and What Can It Do for You?

You can check out their disciplinary history using the SEC’s and FINRA’s online databases. To research the background of deposit brokers who are not affiliated with an investment firm, start by contacting your state’s consumer protection office. For instance, some of the best CD rates you’ll see have unlikely terms such as 5 months, 17 months, or 21 months. It may be to stand out, or perhaps to match an anniversary that the bank is celebrating, or for any number of other reasons. But if you can be flexible in considering these odd-term CDs instead of the conventional term that you were planning, you can sometimes find yourself with a better-paying opportunity.

Certificates of deposit are considered to be one of the safest savings options. A CD bought through a federally insured bank is insured up to $250,000. The $250,000 insurance covers all accounts in your name at the same bank, not each CD or account you have at the bank.

Pros and cons of CDs

Whether you’re building a CD ladder or are saving toward a specific goal with a known time line, stay open-minded to the very best CD deals you find rather than getting hung up on a specific term. This is important because when some banks and credit unions offer a promotional CD to attract new customers, they may stipulate an unconventional term. And though you may incur a penalty if you have to dip into your funds early, the idea is that you would only do this in a true emergency, not for lesser but tempting reasons. All the while, you’ll be earning a better return while the funds are invested than if you had deposited them in a savings or money market account. The main disadvantage of a Certificate of Deposit (CD) is that the money is locked away for a set period and cannot be withdrawn before the maturity date.

You then put one-fifth of the funds into a top-earning 1-year CD, another fifth into a top 2-year CD, another into a 3-year CD, and so forth through a 5-year CD. That would give you five CDs of varying length, each with a value of $5,000. Variable-rate CDs and bump-up CDs typically have lower starting rates than traditional CDs, so you’ll need to weigh that when considering these products. To learn more about relationship-based ads, online behavioral advertising and our privacy practices, please review the Bank of America Online Privacy Notice and our Online Privacy FAQs. But if you’re saving for something five years down the line, a CD with a longer term and higher rate may be more beneficial.

This means that if you need access to the deposited funds early, you could be subjected to hefty penalties and loss of interest earnings. You may also be sacrificing potential growth opportunities as CDs do not keep up with inflation or stock market returns over the same period. Smart CD investors have a specific tactic for hedging against rate changes over time and maximizing their returns. It’s called a CD ladder, and it enables you to access the higher rates offered by 5-year CD terms, but with the twist that a portion of your money becomes available every year rather than every five years. CDs are advertised with their length, yield and compounding frequency. Pay close attention the annual percentage yield (APY), which tells you the interest your money will earn.

If you withdraw the money before that date, you could end up paying some kind of penalty. To get help with determining where CDs fit into your overall investment plans, consider working with a financial advisor. A CD, or certificate of deposit, is a type of savings account with a fixed interest rate that’s usually higher than a regular savings account. It also has a fixed term length and a fixed date of withdrawal, known as the maturity date. You lock funds in a CD for a term generally ranging from three months to five years. CDs don’t have monthly fees, but most have an early withdrawal penalty.

From Better Money Habits

The notice usually offers the choice of withdrawing the principal and accumulated interest or “rolling it over” (depositing it into a new CD). Generally, a “window” is allowed after maturity where the CD holder can cash in the CD without penalty. When you hold a CD, the bank will apply interest to your account at regular intervals. This is usually done either monthly or quarterly and will show up on your statements as earned interest. Just like interest paid on a savings or money market account, it will accumulate and be reported to you in the new year as interest earned, so that you can report it as income when you file your tax return. Savings accounts are also used to put money aside, but they come with more freedom and accessibility since you don’t have to lock away your funds for a set period of time.

SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. SmartAsset does not review the ongoing performance of any RIA/IAR, participate in the management of any user’s account by an RIA/IAR or provide advice regarding specific investments. Because of the compound interest, it is important to understand the difference between interest rate and annual percentage yield (APY). The interest rate represents the fixed interest rate you receive, while APY refers to the amount you earn in one year, taking compound interest into account. Like savings accounts, CDs earn compound interest—meaning that periodically, the interest you earn is added to your principal. Like savings accounts, CDs are considered low risk because they are FDIC-insured up to $250,000.

You can buy them directly from a local bank or go online and shop for the best CDs from different banks and credit unions all over the country. Opening a CD with one of the best rates might mean joining a bank or credit union outside of your primary financial institution, such as an online bank. That move can be worth it, especially to get far better rates than you’d get at traditional banks. With the growth of online banking, it’s now possible to shop for CDs at more than 150 banks that accept customers nationwide and allow for opening an account online. In addition to that, you’ll have access to a number of regional and state banks that will do business with you based on your residency in their state. And many credit unions are available nationwide to anyone who is willing to join an affiliated nonprofit organization for a small fee.

What CD term should I get?

That means that even if the bank or credit union went bankrupt, your principal would very likely still be repaid. For these reasons, CDs are considered one of the safest investments available. Even though opening a CD involves agreeing to keep the funds on deposit without withdrawals for the duration of the term, that doesn’t mean you lack options if your plans need to change. Unlike most other investments, CDs offer fixed, safe—and generally federally insured—interest rates that can often be higher than the rates paid by many bank accounts. And CD rates are generally higher if you’re willing to sock your money away for longer periods.

• As with other types of investment, investors should be suspicious of a CD offering an unusually high rate of return.
• In exchange, the bank agrees to pay them a predetermined interest rate and guarantees the repayment of their principal at the end of the term.
• For instance, if a bank’s lending business is booming and an increasing amount in deposits is needed to fund those loans, then the bank may be more aggressive in trying to attract deposit customers.
• SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S.

Some CD investors also do a shorter version of the CD ladder, utilizing 6-month CDs at the bottom end of the ladder and 2- or 3-year CDs at the top. You thus would have funds becoming accessible twice a year instead of just once annually, but you would earn top rates available for 2- to 3-year CDs instead of 5-year rates. If it’s for a specific goal or project, the expected start of that project will help you determine your maximum CD term length.

The top jumbo CDs (those requiring a minimum deposit of at least $50,000) consistently pay poorer rates than the best CDs that are not marketed as “jumbo” but will take deposits of any size. When considering opening a CD or how long a term to choose, pay attention to the Fed’s rate-setting movements and plans. Opening a long-term CD right before a Fed rate hike can hurt your future earnings, while expectations of decreasing rates can signal a good time to lock in a long-term rate. Every six to eight weeks, the Fed’s Federal Open Market Committee (FOMC) decides whether to raise, lower, or leave alone the federal funds rate. This rate represents the interest that banks pay to borrow and lend their excess reserves to each overnight through the Fed.

CDs Vs. Bonds

Most CDs have a “lock-in period,” meaning you cannot withdraw your money for a set amount of time. Rather than put all the money they want to save into a single certificate of deposit, some people choose to set up CD ladders to ensure a steady flow of modest income. They’ll plan multiple CD purchases so that their CDs mature one after another. Each CD is a rung of the ladder and provides income when it comes due.