Introduction to CDs: Certificates of Deposit

When you hear the term “CD” you might immediately think of the round, flat disc that you stick into a player to hear music. There’s another kind of CD you should know about, one that can help you earn a little bit of money.

CD is an acronym for certificate of deposit. This is type of low-risk investment you can open at a bank or credit union. You agree to leave your money in the CD for a certain amount of time and the bank pays interest on your deposit. After the term is up, your CD has “matured” you can withdraw your initial investment plus the interest you earned.

Withdrawing Your Money

You can often choose whether your investment automatically renews. With automatic renewal, your CD and interest are re-invested into a new instrument for another period. You may have a certain window of time after maturity to withdraw your funds before they’re automatically re-invested. Pay close attention to this timeframe if you want to withdraw your investment and earnings.

You can withdraw your investment before the term ends, but if you do, you’ll face early withdrawal penalties and could possibly forfeit some or all of the interest you earned. Early withdrawal penalties vary by CD, so make sure you read the terms before you purchase. Some CDs are no-penalty, but these usually have lower than average interest rates.

Minimum Deposit Requirements

Some CDs have minimum deposit requirements, e.g $500 or even $25,000 or higher. Know how much you can afford to put into a CD before you start shopping around. You may be lucky enough to find a good CD that doesn’t have a minimum deposit requirement.

How Long Does a CD Last?

You can purchase a CD for terms as short as three months and as long as 5 or sometimes even 10 years. Generally, the longer you leave your money in the CD, the higher the interest rate you can receive. Interest rates on CDs are low compared what you may received from stocks, but higher than a savings account. You can check the current CD rates at your bank or a website like Bankrate.com. Note that some of the best paying CDs are from online-only banks. Don’t rule those out if you’re looking for an excellent rate.

How CD Rates are Determined

CD rates generally follow the Federal funds rate, the rate at which banks lend money to each other. When the Fed funds rate is low, CD rates will also be low. And when the Fed fund rate increases, CD rates will soon follow. Pay attention to news about the Fed rates. When the Fed announces they’re planning to keep the rate low for the next year, you know that CD rates will probably remain about the same for that period of time.

A traditional CD has a rate that doesn’t change during the term. There are variations of non-traditional CDs with rates that can fluctuate throughout the term of the CD based on another index.

Protection From Bank Failure

Unlike other types of investments, your funds in a CD can be protected in case of bank failure if you open your CD at an FDIC- or NCUA-insured institution. Make sure the bank you’re considering is a member of the insurance associations so you know your funds are safe. Beware that some CDs may be issued from non-insured institutions with names that sound like legitimate banks. You can check FDIC.gov or NCUA.gov to ensure you’re depositing funds with an insured bank.

Source: FDIC.gov