Certificates of deposit (CDs) are one of the simplest, safest ways to invest your money. They generally have a higher interest rate than savings accounts or money market accounts, but not as great a potential return as riskier investments. Remember, with financial investments, there’s usually a strong correlation between the risk you assume and the possible rewards.
If you’re curious about CDs, look over this introduction to certificates of deposit. It covers the most important basic information and answers the most commonly asked questions about them.
Key Features of Certificates of Deposit (CDs)
- CDs are purchased through a traditional or online bank or a credit union; they are safe because they are FDIC insured (or covered by NCUA insurance if you go through a credit union)
- The tradeoff for a higher interest rate than with a savings or money market account is that you lock up your money for a set period (the CD’s “term”)
- Certificate of deposit terms are typically anywhere from one month to five years (common terms include 1, 3, 6, 12, 18, 36, and 60 months)
- The longer the term, the higher the interest rate offered
- You can usually withdraw your money early, but you’ll pay a penalty that may eat up all your profit, and possibly even some of your initial investment (i.e., you could lose money on the deal)
- Longer terms may seem more appealing due to the higher yield, but they aren’t always best; for example, you may need your money before the term is up, or, if you invest when interest rates are low, you may be locked into a low rate for several years rather than having the opportunity to reinvest at a higher rate in the near future
- When the term is up (the CD “matures”), you have the option to receive payment or to reinvest in another CD of your choosing
- If you don’t respond to the maturity notification, the issuing bank or credit union will usually automatically reinvest the money in a new CD with the same term (but the interest rate is unlikely to be exactly the same)
- In light of the preceding bullet points, don’t overlook the option of continuously reinvesting in short-term CDs
- A common CD strategy is to divide the investment funds among multiple certificates of deposit with different terms so that money regularly becomes available (for withdrawal or reinvestment)
- Sometimes you find CDs with more flexibility, such as penalty-free early withdrawal or the ability to bump up to a higher interest rate if rates rise during the term; however, the tradeoff for greater flexibility is a lower starting interest rate
- While you can’t predict the future, as far as timing is concerned, it makes sense to buy CDs when you believe interest rates are high and will only drop in the near future
Interested in Investing in CDs?
Shop around, and don’t overlook online-only banks. Be sure to discuss your options with the issuing institution. Ask about all the terms available and be sure to find out about the early withdrawal penalty. Also, inquire about other investment products that may be a better fit. Your professional financial advisor can also inform you about smart investment options for your financial circumstances and goals.