Certificates of Deposit (CDs) and how it works

Certificates of Deposit (CDs) are fixed-term deposit accounts offered by banks and credit unions that typically offer higher interest rates than traditional savings accounts.   Here’s how CDs work:

1. Deposit Period:

When you open a CD, you agree to deposit a specific amount of money with the financial institution for a fixed period, known as the term or maturity period.   CD terms can range from a few months to several years, with longer terms typically offering higher interest rates.

2. Interest Rates:

• CDs offer fixed interest rates that are determined at the time of opening the account.   The interest rate remains constant throughout the term of the CD, providing predictability and stability in earnings.   Generally, longer-term CDs offer higher interest rates than shorter-term CDs to compensate for the longer commitment.

3. Interest Payments:

• Depending on the terms of the CD, interest may be paid out at regular intervals (such as monthly, quarterly, semi-annually, or annually) or compounded and paid out at the end of the term.   With compounding, the interest earned is added to the principal balance, allowing you to earn interest on interest.

4. Fixed Term:

• Once you deposit funds into a CD, you agree to keep the money in the account for the entire term of the CD. Withdrawing funds from a CD before the maturity date typically results in an early withdrawal penalty, which may include forfeiting a portion of the interest earned or paying a penalty fee.

5. FDIC Insurance:

• CDs offered by FDIC-insured banks are generally protected by the Federal Deposit Insurance Corporation (FDIC) up to the maximum allowable limit.   This insurance provides assurance that your deposits are safe, even if the bank were to fail.

6. Low Risk:

• CDs are considered low-risk investments because they offer guaranteed returns and principal protection (up to the insured limit).   As long as you keep your funds in an FDIC-insured institution within the coverage limits, you can have confidence in the safety of your investment.

7. Liquidity Considerations:

• While CDs offer higher interest rates than traditional savings accounts, they also come with less liquidity.   Withdrawing funds from a CD before the maturity date typically results in penalties or fees.   Therefore, CDs are best suited for funds that you don’t need immediate access to and can afford to keep locked away for the duration of the term.

Overall, CDs can be a valuable component of a diversified savings and investment strategy, offering a secure way to earn higher interest rates on your savings over a fixed period.   By understanding how CDs work and considering your financial goals and liquidity needs, you can determine whether CDs are the right option for you.