When it comes to investing your money, there are several options available. A Certificate of Deposit or simply CD is one of these options. But what is it and how does it work?
What is a Certificate of Deposit
A certificate of deposit, or CD, is a deposit provided by banks, thrift institutions, or credit unions that allows you to deposit money for a fixed term and at a fixed interest rate. CDs usually have a higher interest rate than savings accounts but in exchange, you need to keep your cash in the bank for a determined period of time. However, you get to choose how long you want to keep your money locked-up in the deposit.
CDs are a great way to invest money at a higher interest rate than savings accounts and you can open them in different types of accounts from individual retirement accounts and joint accounts to trusts or even custodial accounts.
Traditionally, the interest rate was fixed and you would need to pay a penalty if you wanted to cash out early. Nowadays, CDs come in different types and have different rules so you have more choices.
Types of CDs available
There are a variety of CD types you can choose from, each of them with specific policies. Here are briefly the main types of CDs available, although there are many more you can choose from.
- Traditional CD: you deposit a certain sum and earn a fixed interest rate. You usually need to pay high penalties for early withdrawal.
- Liquid CD: also called no-penalty CD, it allows withdrawal before the end of the term without a penalty. These CDs usually have lower interest rates.
- Bump-up CD: gives you the option to request a higher interest rate or a bump-up.
- Step-up CD: similar to the bump-up except you don’t need to request a higher rate, the institution will raise it automatically.
- Brokered CD: sold through brokerage firms so you need to have a brokerage account. They usually have a higher interest rate but are riskier.
- Jumbo CD: requires a higher initial deposit but sometimes may have higher interest rates.
Pros and cons of CDs
Some pros of opening a CD are the higher interest rates, the possibility to choose from a variety of options, and the fact that most of them are insured by the federal government.
However, CDs have some disadvantages, mainly the fact of having to lock your money in the deposit for a specific term and having to pay penalties for early withdrawals. They also don’t keep up with the rate of inflation.
If you do decide to buy a CD, make sure to choose one that is insured through the Federal Deposit Insurance Corp or the National Credit Union Administration. Pay attention specifically to CDs offered by brokerage firms.