What is a certificate of deposit?
A Certificate of Deposit (or CD) is a way of earning interest on the money you are saving by locking it away for a certain period of time.
They are called CDs because when you deposit your money, banks give you a certificate telling you:
- The amount you deposited
- The interest rate being paid
- How long the money must remain in the account
Calculator: How fast can your money grow?
Banks usually issue CDs and the time frame can range from several months to five years.
CDs keep your money safe while earning interest, similar to a savings account. However, if you try to take money out, there will be penalties.
Components of a CD
- Denomination – how much
- Maturity Date
How do CDs work?
1. You buy a CD at a certain price.
2. It has an interest rate that will compound (calculate interest on previously accumulated interest) annually.
3. The CD will earn money for just sitting there.
4. At the end of the term, the CD will mature and you will receive your original amount + interest.
So if you purchase a $10,000 CD with an interest rate of 4% and a term of one year. After a year the CD will have grown to $10,400.
($10,000 x 1.04) = $10,400.
Pros and cons
- Considered very safe.
- Fixed or variable interest rates. You can anticipate the rate at which your balance grows, so making plans for the future is that much easier.
- Easy to open- you do not need the assistance of a financial advisor or bank.
- Low liquidity – requires that you keep your money on deposit for a set time frame before withdrawing it in order to avoid early withdrawal penalties.If you think you may need this money for a possible financial emergency, consider a liquid CD, which allows you to withdraw your money and the interest earned at any time without paying an early withdrawal penalty any time after the first 6 days of funding your CD.
- Low interest rates – traditionally lower rates compared to other investment opportunities.
Types of CDs
|Type of CD||Pros||Cons|
|Variable Rate||Take benefit of future rate increases because sometimes linked to a market index||Assume more risk-if rates go down, you would earn less on your CD|
|Liquid||No penalty for an early withdrawal||Lower amount of return; Requires you to maintain a minimum balance|
|Callable||Higher interest rate in the noncallable period (cannot be redeemed)||Bank can "call" the CD or redeem the CD earlier|
|Jumbo||Higher interest rates||High minimum balance (typically $100,000 or more)|
|IRA||You'll know exactly how much you'll earn on your CD over its term, allowing you to plan your retirement date||Vulnerable to inflation; inadequate growth|
Should I invest in a CD?
Can you set money aside and not touch it?
Do you already have emergency funds?
Do you need portfolio stability?
Can you handle loss on inflation?
If you answered “yes” to all of these questions, it may be a good time to start investing in CDs. Consult with your financial advisor.
- CDs are a good place to put extra money for relatively short amounts of time.
- CDs are considered a safe investment, but their low interest rates mean your money grows slowly.
- You must pay penalties if you withdraw your money before the CD has fully matured.
- Ukraine offers the highest interest rate, with 19% APY.
- The US Iran and Mongolia offer 18.03% and 15.10% respectively.
- In the United States, deposits are protected by the FDIC (Federal Deposit Insurance Corporation).
- 70% of people have never put money in a CD.
- CDs were designed when interest rates were more rewarding (4 or 5%) but now, when combining low interest rates with inflation, people can actually “lose” money.