Certificates of Deposit, or CDs, are an investment vehicle designed for the longer-term investor. With a CD you commit to keeping your money at the bank or savings institution for a specific period of time, and in return the bank agrees to pay you a higher rate of return than is paid on the familiar savings or checking account. Certificates of Deposit have a variety of rates and terms, and investors should check carefully to find the best CD rates and terms for their savings goals.
The term of a CD can be anywhere from one month to 10 years or even longer. Typically, the longer the term, the higher the interest rate paid on your money. However, the longer the term the more you, the investor, expose yourself to interest rate risk. This happens when your money is tied up in the CD at one rate while interest rates on other investments are rising. For example, if you buy a 5-year CD at 3%, and one year into the term rates have risen to 5% or even 6%, you are now earning a much lower rate than could be had elsewhere.
The interest rates on CDs tend to rise along with the term of the CD. For example, a 6-month CD might have a rate of 1%, while a 5-year CD might have a rate of 3%. The bank is paying you extra for keeping your money on deposit for a longer period of time.
Penalties and fees
Because of the fact that CDs are designed to be a long-term investment, many of these accounts have an early-withdrawal penalty attached. Should you withdraw your money before the term is up – even one day early – you will be charged a penalty. If your CD has not earned enough interest to pay the entire penalty amount, you could end up withdrawing less from the bank than you originally deposited. The funds you invest in a CD should be funds you know you will not need during the term of the CD. Examine the fee and penalty chart prior to investing your money so you will know what restrictions apply to your account.
Nearly all CDs have minimum deposit requirements. Often they are quite reasonable, ranging from $500 to $1,000. Some banks have much higher minimums – often over $10,000 – but these CDs may pay an even higher interest rate.
Opening a CD at a bank or savings and loan can often provide additional benefits. Many institutions provide online banking access, so you can check your account at any time. More and more banks offer mobile banking, allowing you to check your account or transfer money via your mobile phone. Especially if the Certificate of Deposit won’t be your only account at a bank, some of these other conveniences may be a good reason to invest. In the United States, CDs at banks and savings and loans are insured (up to $100,000) by the FDIC or FSLIC, so you know that your money is safe.