As your savings grow and your all-important emergency fund nears that three to six months of living expenses you might need in a crisis, you'll find you can afford to let the bank lock up some of your savings for a period of time. In return you can expect the bank to give you more interest than they pay on your savings or money market account, which is liquid.
At a glanceA certificate of deposit, or CD, is an excellent way to save money and earn a higher interest rate than you would with most money market investments. The drawback is that CDs are not liquid; you're tying up your funds for a period of time, and if you cash out early you'll lose interest and possibly principal.
CDs are time-based, fixed-income investments that are most often issued by banks but can be purchased through brokerages. Some banks might require you to come into the bank to open a CD account, others may let you open one online.
Typically, you invest a fixed amount of money for a predetermined amount of time called the term. In return, you're guaranteed a fixed amount of interest, which is added to your account periodically throughout the term. If you have a longer-term CD, you may decide to withdraw the interest payments as they are received.
When the term expires, you can cash out or roll over the CD for another term.
Certificate of deposit
- Earn higher interest rate than money market accounts.
- Time-based fixed income.
- Hands off investment until CD matures.
- Early cash-out has interest and possible principal implications.
- Interest payments may be withdrawn as they are received.
- FDIC insured up to $250,000 per individual.
- Available at banks and online.
CDs can be purchased for terms of almost any duration although the most popular are between three months and five years. Almost always, the longer you allow the bank to use your money, the higher your interest rate. Generally, it's not a good idea to buy a CD with a term of more than five years. The interest rate situation could change dramatically during that time and you could get stuck with a long-term, low-rate CD.
CDs are deposit accounts and are insured by the FDIC up to $250,000 per individual.