Certificate of deposit
What is a certificate of deposit?
A certificate of deposit (CD) is a type of savings account usually issued by commercial banks, which restricts your access to the money you invest but offers much higher interest rates than those associated with regular savings accounts. The deposit gains value over an agreed-upon duration, but it could be subject to fees if withdrawn before the end of that time.
When a customer opens a CD account with a bank, she invests a specific amount of money for a set period. The issuer pays interest at regular intervals until the date of maturity, at which time the account holder receives her original investment, plus all of the interest. A CD with a shorter maturation time will offer you a decent return, but it pays to invest in a longer-maturing CD, which usually has a higher yield.
Compared to regular savings accounts, CDs offer a higher yield to compensate for the loss of liquidity. They also represent a low-risk investment opportunity because the account holder needs little understanding of investment markets and they’re insured by the FDIC up to $250,000. Some banks allow for a variable rate of interest and others may index the CD to the stock market or other indices. Interest rates are almost always tracked to inflation.
While banks assess penalties on CD customers who withdraw from their principal deposit before the date of maturity, some banks allow the CD owner to withdraw from the interest accrued during the CD’s term, although this would reduce earnings. Some CDs automatically roll over, applying the interest to the principal and thus compounding the owner’s earnings, while others stop receiving interest after the maturity period and can be either manually renewed or withdrawn in full.
Use Bankrate’s CD calculator to find the best way to get started.
Certificate of deposit example
Garfield has a little extra cash from running a successful lasagna restaurant. Being a cat, he doesn’t know much about investing, but he would like to grow his money with minimal effort. He opens up a $20,000 CD with a two-year term and a 3 percent rate of interest, and at the end of the two years it has matured and is now worth $21,218.