What Is a CD?
Certificates of deposit (CDs) are one of the best alternatives to savings accounts. You can find CDs at banks and credit unions, but many online banks also offer CDs. CDs offer several benefits to help you build wealth. If you’re looking to save money and boost your earnings, CDs are a great tool to add to your financial toolbox.
What Is a Certificate of Deposit?
A certificate of deposit (CD) is an investment that requires your money for a set time period, usually from a couple of months to close to 10 years.
- A CD is a contract between you and a bank. When you purchase a CD, you typically deposit a fixed amount of money for a predetermined period of time. You can’t withdraw your money early without paying a penalty. So when you invest in a CD, you are paying for the added security of extra interest and more flexibility in when you get to access your money.
- When you open a CD, you agree to leave the money in your account for a specific amount of time. For this reason, you can’t close your CD before its maturity date. If you withdraw money from your CD, you will need to pay an early withdrawal penalty, generally the percentage of interest you could have earned.
Who They're Best For
Since they are so inexpensive, CDs can be a good place to start building wealth because you won’t have to risk as much capital in order to grow your money. If you’re just getting started with investing, CDs will make it simple to start with a small deposit. Additionally, since they come with a fixed rate of return, they’re good for people who want a guarantee that they’ll earn the promised amount on their money.
Types of CDs
There are several different types of CDs. A basic type of CD is a standard CD, which is a time deposit that you make for a specific amount of time. Interest is usually compounded monthly or annually.
There are also IRA CDs, which are what they sound like CDs you can open within an IRA so that you can invest money within the IRA for a specific amount of time.
A fixed term CD is a CD that has a fixed length of time, such as two years or five years. You will usually have to pay interest on the amount of the CD for the entire term, even if you withdraw money early.
Some banks will let you deposit money in a CD with a notation that you can withdraw money before the CD matures if you come up with specific reasons why. This is called an early withdrawal penalty.
IRA CDs often will not have early withdrawal penalties, which means you can withdraw money from the CD before it matures without having to pay a penalty.
There are also bump CDs, which are CDs that replace previous CDs and have a longer term than the previous CDs.
An escalator CD is one that will increase in rate after the first year. As an example, if you invest in a CD that has a 2% rate and it becomes an escalator CD after the first 12 months, the rate could increase after the first year to 2.25%.
5 Things You May Not Know About CDs
CDs are more flexible than they may appear.
CDs Can Let You Predict the Eventual Total of Fewer Monthly Payments
If you expect to deposit a set amount each month into your CD, you don’t want to commit to a term that ends just as your monthly payments reach your goal. By locking into a shorter term, you may wind up with a larger final balance.
CDs Can Earn More Money Than You Thought
Traditional CDs usually carry higher interest rates than checking and savings accounts. It’s a common misconception, however, that the interest rate is all you get with a CD.
Most CDs will automatically renew at the end of maturity
When a CD matures it frequently will automatically renew into a new CD at the terms and conditions of the new CD. But sometimes the bank will offer the option of extending for a term longer than the original CD. This can be a great way to increase the interest rate on your CD without having to worry about other financial obligations coming up that would prevent you from taking advantage of the higher CD interest rates.
One catch is you will have to notify them before the maturity date. Once the bank receives the maturity notice they have one opportunity to make a counter offer.
Not all CDs have early withdrawal penalties
If you want to be able to withdraw funds quickly from a certificate of deposit (CD), you may have to face a substantial penalty for doing so. But fortunately for consumers, CDs are governed by the same laws that cover savings accounts. Under the typical penalty structure for CDs, you would be subject to a penalty if you withdrew funds within six months of making the deposit. However, there are some banks that offer CDs that do not have a six-month penalty.
You can open multiple CDs at one time
The interest rate you receive may depend on how long you keep your money in your account.
You typically have to sign up for CDs for up to five years. But you can split your money up and open a CD with multiple banks or credit unions. What happens if you decide to roll your money out of one of the accounts but not all of them? You will pay a penalty, so make sure you know the terms of your CD before you sign on the dotted line.
Minimum deposits, lengths of terms and rates will vary by bank and type of CD
Since you don’t have easy access to your money, CDs are a less risky choice of investment for banks when compared to savings accounts. For investors, you have guaranteed rates of return that will usually be higher than what you can get for an investment account.
CDs are different from savings accounts because they’re not just about depositing your money and letting it sit. CDs, like the name suggests, are a Certificate of Deposit. A certificate of deposit refers to a contract with a financial institution. With this document, you’re agreeing to deposit a fixed sum of money for a designated amount of time. The bank, on the other hand, agrees to pay you a fixed amount of interest for a certain amount of time. If you hold the CD till its maturity period is over, you’ll be guaranteed to earn a higher interest rate than a savings account.
There can be hidden fees
Attached to directly deposited funds. These fees are often a surprise to consumers and can be a frustrating experience. If possible, consider doing business directly with an investment firm without hidden fees on their CD rates.
If you have a CD from a major bank, most of these fees are rising automatically on you. If you want to know the current rate, call the bank directly.
It might not be worth opening a CD account at a big-name bank for a couple of bucks in interest. However, if you must do a business with a bank, you should ask the bank to remove the fee. You may be surprised that the bank will agree to do this, and you will receive your interest rate on the full amount. A bank that doesn’t do this may be going out of business and not be able to return your original investment.
Of course, the big advantage of opening a CD is a much higher annual percentage yield. If you have a significant amount of money to invest, then a CD can be an excellent investment option for you.
Pros of a CD
Certificates of Deposit (CD) are one the most popular investments because of their safety and potential for growth. The money invested in a CD is held in the bank, and a specific amount of interest is added to the investment at the end of a designated amount of time, allowing the money to grow, tax-free. Any bank can offer CDs. It is up to you to decide which bank is best for you. A few things to consider when choosing a CD is the amount you want to invest, the amount of time you wish to have your money invested, and the amount of interest you want.
If you wish to have you money available immediately, you may want to avoid CDs. Banks will limit the amount of money you can withdraw from a CD before the time expires. If you want to have your money available, you will need to have it available before you deposit it in the CD.
Due to the high interest rate of a CD, banks have very few accounts in which to place your money. Because of this, you will be paying a fee of more than a few dollars to close your account, as the bank already has plans for your money. You can also avoid the fee by using the money in a different account with the same bank or by transferring the accrued interest to another account.
CDs are a great way to invest your money for a short period of time, as they have high interest rates, and are easily accessible.
Cons of a CD
A CD isn’t the most flexible investment option. In fact, flexibility actually can be one of the CD’s biggest drawbacks. While you can convert a CD into cash before it matures, you’ll usually have to pay a penalty.