A certificate of deposit, or CD, lets you lock up money for a specified number of months or years in exchange for an interest rate that’s traditionally higher than the market rate for an interest-bearing savings account.
CDs have been out of favor as interest rates have remained low. More often than not, CD rates have been merely on par with high-yield savings accounts rather than more appealing.
Still, some savers like CDs, and some exotic variations can offer benefits even when rates are at historic lows.
Are you well-educated about the various types of CDs? Test your knowledge with this true-or-false quiz.
1. A CD ladder lets you access cash at regular intervals.
One CD locks up one sum of money for one set period of time. A ladder of CDs with various maturities locks up smaller sums for multiple time periods. The advantage of a CD ladder is that smaller sums are freed up periodically as the CDs mature.
2. A CD barbell is a CD ladder that includes only short-term and long-term maturities.
Unlike a ladder, a barbell offers you greater short-term liquidity so you can take advantage of higher rates if an opportunity arises. The short end of the barbell could be a high-yield checking account or money market fund instead of a CD to make the investment even more liquid.
3. CDARS, pronounced like the tree, is an environmentally responsible CD that offers only electronic statements, not paper statements.
The Certificate of Deposit Account Registry Service, or CDARS, allows you to stash more than $250,000 in CDs at one bank and still have the full amount insured by the Federal Deposit Insurance Corp., or FDIC. When you place your large-dollar deposit with member bank of the CDARS network, your deposit is divided into smaller amounts and placed with other CDARS network members. Those member institutions issue CDs in amounts under $250,000 so that your deposit is eligible for FDIC insurance at each member bank. The CDs purchased by the bank through this system won't necessarily offer the best rates, but CDARS can be a convenience.
4. You can break out of liquid CDs without a penalty.
Also called no-penalty CDs, liquid CDs allow you to make one or two penalty-free withdrawals during the CD's term. The trade-offs are that liquid CDs may have higher-than-usual minimums and the withdrawal option likely will have certain restrictions.
5. A bump-up CD comes with an option to get a higher rate if market rates increase.
A bump-up CD might make sense if you believe interest rates are likely to rise. However, the initial rate might be lower and you'll have to decide when to bump up. Typically only one or two bumps are allowed during the CD term.
6. A step-up CD lets you add more money to the CD before it matures.
A step-up CD means the bank will hike the rate, usually once or twice, during the term. Unlike a bump-up CD, a step-up CD has predetermined rate rises that are made not by you, but by the bank.
7. If a CD is callable, the bank will call you to let you know when a higher rate is offered.
If a CD is callable, the bank has the option to call in the CD and return your deposit or give you another CD with a lower rate. Callable CDs can offer slightly higher rates than their non-callable cousins due to the risk that an attractive rate might end before the CD matures.
8. Brokered CDs are safer than bank CDs.
Buying a CD through a broker can be a good way to shop for a higher rate, but if the broker isn't honest, your funds could be stolen. If you buy a brokered CD, verify that the issuing bank is FDIC-insured and that the CD is a deposit, not an investment. Read the fine print and make sure you understand any fees or early withdrawal penalties.
9. Structured, indexed and market-linked CDs are good choices for unsophisticated investors who want to keep their finances simple.
In fact, these nontraditional CDs are very complex compared with traditional CDs. These nontraditional CDs are linked to the performance of an index or basket of securities and not a bank interest rate. They can offer the potential of a higher return but can also result in losses if you sell the CD before its maturity.