Certificate of Deposit (CD)
January 4, 2023
What is a Certificate of Deposit?
A certificate of deposit (CD) is considered one of the safest options for those looking to earn interest on their money, as FDIC-insured banks offer deposit insurance of $250,000 per depositor, per insured bank, for each account ownership category. A CD is a savings account that holds a set amount of money for a fixed period, with options typically ranging from three months to 10 years. To compensate for the opportunity to hold your money, the deposit institution – oftentimes a bank – will pay you interest. Once you reach the time limit, known as the maturity date, you will retain your original investment plus the interest earned over that period, as long as you adhere to the guidelines outlined by the deposit institution.
A CD calculator is a helpful resource when seeking to figure out how much interest you can earn over the life of a CD. Simply input your initial deposit amount, the length of time, the interest rate, and the frequency in which the interest will compound. After entering this information, the tool will also tell you the annual percentage yield (APY) associated with the CD.
How do CDs differ from savings accounts?
CDs tend to have higher rates than regular savings accounts. The primary reason CD rates are higher is because depositors typically cannot access the funds during the period without paying an early withdrawal fee. On the other hand, savings accounts offer the freedom to withdraw or deposit money at any time. Additionally, CD rates, if associated with a fixed-rate CD, do not change, while savings rates change over time.
What are the Benefits of a CD?
CDs are beneficial because they allow you to safely earn interest on your money regardless of market conditions, as the FDIC insures CDs up to the maximum amount regulated by law. This is especially beneficial when the market is down and rates are high. The stock market may not be the best solution when this is the case, because it leaves investors vulnerable to the risks of gaining or losing large sums of money over a short period of time. In contrast to the market and other savings accounts with variable rates, a CD with a fixed rate over a fixed term will yield a predictable return over its life span. This is ideal for savers who have a specific goal in mind.
The absence of a monthly fee is a key benefit of a CD, but it is important to recognize the fees associated with withdrawing money before a CD reaches the end of its term. Before agreeing to the terms, you should think about how long you are willing to forgo access to a certain amount of money. If you are fine with having $3,000 stored in a CD for two years but feel apprehensive about raising the amount and time to $5,000 over three years, then stick to the terms with which you are most comfortable. After all, if you end up withdrawing early and receive a penalty, it will negatively impact the return you receive from the CD.
What happens when a CD matures?
Once a CD reaches its maturity date, there is typically a week when you can withdraw funds. After that time, most CDs automatically renew for the same term. However, the renewal rate often reflects the rate offered for new CDs with the same term, not your CD's original rate. You will want to prepare your next steps before the maturity date so you are able to make a decision that best suits your financial needs and goals.