What Is a Certificate of Deposit?

A certificate of deposit, or CD, is a savings vehicle with a fixed deposit held for a fixed term and that produces a fixed interest rate.

Learn how a CD works through an example, its pros and cons, and the alternatives to determine if you should incorporate it into your savings strategy.

What is a certificate of deposit?

A CD is a type of savings account offered by banks and credit unions that contains a fixed amount of money and is held for a fixed period of time ending on the "maturity date", during which time your money normally accrues interest.

A fixed rate expressed as an Annual Percentage Yield (APY). This makes the product a great way to save toward a financial goal in a specified number of years in the future. However, you will normally be charged an early withdrawal penalty if you withdraw money from the CD before the expiration date.

Alternative name: term deposit

Some banks offer variable rate CDs whose rates change over time. Among these CDs, some offer a multi-step structure where rates change according to a predefined schedule, while others attempt to earn interest at a rate that follows a particular market index.

How a certificate of deposit works

A CD works like a savings account in the sense that you earn interest in exchange for keeping your deposits with a financial institution.

The difference is that once you deposit the funds on the CD, they are actually locked; You cannot withdraw principal or interest without incurring an early withdrawal penalty.

Once the CD has expired (which could take three months or potentially five years), your bank or credit union will generally offer a grace period to decide whether to renew the CD or withdraw the funds. If you choose to withdraw the funds, you will receive accrued principal and interest.

However, if your financial institution has an automatic renewal feature and you have not disabled this feature, the funds will automatically be transferred to a new CD when the grace period ends.

For example, let's say you want to raise a small fund for a trip in five years. Knowing that you will need the funds in five years, but don't need to access them until then, open a CD at your local credit union with a five-year term and 2% APY with compound daily interest.

Deposit $ 1,000 and turn off the auto-renew feature. He waits patiently until the expiration date five years later and then chooses to withdraw the funds from the account, which now total $ 1,104.08.

Our CD deposits are federally insured for up to $ 250,000 per bank, per depositor, through the Federal Deposit Insurance Corporation (FDIC) insurance for banks or the National Credit Union Stock Insurance Fund (NCUSIF). ) for credit unions.

Types of certificates of deposit

You have several options when it comes to CDs:

Traditional CDs - These are regular CDs that earn a fixed interest rate for a fixed period of time and come with an early withdrawal penalty.

High Yield CDs - These are virtually identical to traditional CDs, but offer above-average interest rates in exchange for longer CD maturities and larger minimum deposits.2

Penalty-free CDs - These accounts allow you to withdraw funds from the CD after a certain period of time without incurring an early withdrawal penalty, giving you easier access to your money than traditional CDs.

Reinforced CDs - These CDs allow you to ask the bank to increase your rate once during the life of the CD to the current rate being offered to take advantage of rising interest rates. They are a great way to hedge against the inflation risk that CDs pose.

Enhanced CDs - Similar to Enhanced CDs, except that the financial institution increases your rate at designated intervals rather than being instructed to do so.

Pros and cons of certificates of deposit

Pros

Attractive and generally fixed rate of return

safe investment

Variety of terms

Ability to distribute deposits across multiple CDs

Cons

Penalties for early withdrawal

Inflation risk

Lower returns than some investments

 

We hope you enjoy watching this video about the Certificate of Deposit

Source: Concerning Reality

 

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