A certificate of deposit (CD) is a special kind of savings account that earns a fixed interest rate for a set period of time. It is available at banks and credit unions. Unlike regular savings accounts, you cannot touch the money in a CD until the agreed-upon time is over, or else you will have to pay a penalty. CDs generally offer higher interest rates compared to regular savings accounts to encourage you to keep your money invested.
Learn more about CD
When you open a CD, it’s like opening a regular bank deposit account. The key difference lies in the terms you agree to when you finalize the deal, whether it’s a physical or digital signature. Once you’ve chosen the CD(s) you want, finalizing the process will commit you to four specific terms.
- The interest rate: Most CDs have a fixed interest rate, but there are also variable-rate CDs available that can give you a higher return if rates go up. If you choose a fixed-rate CD, you’ll know exactly how much you’ll earn at the end of the term. However, if rates increase after you’ve locked in, it could be disadvantageous for you.
- The term: This refers to the length of time that you agree to keep your money deposited in order to avoid any penalties. For example, there are 6-month CDs, 1-year CDs, 18-month CDs, and so on. The term ends on the maturity date, which is when your CD has fully matured and you can withdraw your funds without any penalties.
- The principal: Unless it’s a specialty CD, the principal is the amount of money you agree to deposit when you open the CD.
- The institution: The bank or credit union where you open your CD will determine certain aspects of the agreement, such as early withdrawal penalties (EWPs) and whether your CD will be automatically reinvested if you don’t provide any instructions at the time of maturity.
Why Should You Open CD?
CDs provide stable and secure interest rates, which are usually insured by the federal government. These rates can be higher than what bank accounts offer. Additionally, longer investment periods typically result in even higher CD rates.
CDs are now more appealing to savers who desire higher earnings compared to savings, checking, or money market accounts. This option allows them to avoid the risks and fluctuations of the market.
Pros
- Rates are typically higher than savings or money market accounts
- Guaranteed, predictable rate of return is less risky than volatile stocks and bonds
- Federally insured if opened with an FDIC- or NCUA-insured bank or credit union
- Can help you avoid spending temptations since withdrawing funds early triggers a penalty
Cons
- Penalties for withdrawing funds early
- Typically earns less than stocks and bonds over time
- Fixed rate could cost you if interest rates rise during the term
- Inflation can eat away at the value of money locked in at a fixed rate
Conclusion
Certificates of deposit provide a secure option for individuals seeking higher returns on their savings without the volatility of stocks and bonds. It’s important to carefully review the terms and conditions, as interest rates can be more favorable compared to regular savings accounts and money market funds. However, locking in your funds for extended periods may result in missed opportunities for increased interest earnings if federal rates rise. Early withdrawal is possible but may incur penalties that could impact your initial investment. Understand the pros and cons of your investment before committing.