A CD, or Certificate of Deposit, is a financial product offered by banks and other financial institutions. It's a time deposit account that pays out a fixed interest rate on the initial investment for a specified period of time.
Certificates of Deposit, often referred to as CDs, are a popular type of savings account that offers a fixed interest rate. Here's a breakdown of the different types of CDs available: traditional CDs, no-penalty CDs, jumbo CDs, bump-up CDs, step-up CDs, zero-coupon CDs, callable CDs, and IRA CDs.
Protection for Your Money
If the institution issuing CDs is FDIC-insured or NCUSIF-insured, your money is protected up to $250,000 in the event of a bank or credit union failure.
Interest Rates and Federal Funds Rate
Changes to the federal funds rate commonly impact CDs. Banks tend to raise their APYs when the Fed raises rates, and lower APYs when the Fed cuts rates.
CDs for Growing Funds, Not Emergency Funds
CDs can be a good choice for growing funds for a future purchase or expense, but they might not be the best place for emergency funds.
Grace Period and Maturity
A CD's grace period typically lasts between five and 10 days. When each CD matures in a CD ladder, you can choose to extend the ladder by reinvesting the money in a new CD, or you can choose to use the money for planned expenses or other investments.
Early Withdrawal Penalties
Early withdrawal penalties on CDs are fees charged when you take money out before the CD matures. These penalties are generally calculated based on a certain amount of interest you would have earned if you left the money invested until maturity. The penalty amount depends on the bank’s terms, but common formulas are:
- If the penalty is calculated by day: Penalty = (Amount withdrawn) × (Annual interest rate ÷ 365 days) × Number of penalty days
- If the penalty is calculated by month: Penalty = (Amount withdrawn) × (Interest rate ÷ 12 months) × Number of months’ interest
For example, if the penalty is 180 days’ interest on a 3.90% APY CD and you withdraw $1,000 early, the penalty would be approximately $19.23: $1,000 × (0.039 ÷ 365) × 180 = $19.23
CDs as a Low-Risk Investment
CDs are considered low-risk investments and might earn more than a savings account, but they'll likely earn lower yields than money in the stock market. It's important to remember your CD's maturity date, especially if you need the money, because withdrawing the funds after the grace period is over will result in an early withdrawal penalty.
CD Ladder Strategy
A CD ladder is a strategy in which you open multiple CDs at once with different maturity lengths. With a CD ladder, you can benefit from competitive APYs on longer-term CDs, while freeing up some of your money sooner with shorter-term CDs.
CD Availability
CDs are offered by banks, credit unions, and brokerage firms. The minimum opening deposit requirements for CDs vary among banks.
CDs vs Savings Accounts
CDs earn a fixed APY, while savings account APYs are variable and can change over time. When the CD's term ends, it matures, and you can choose to renew the CD or withdraw the funds.
- For individuals looking to expand their personal-finance portfolio, money market accounts or savings accounts for investing may be considered in addition to CDs, as CDs might not yield as high returns as stocks in the long run.
- Businesses may find it beneficial to explore various finance options, such as money market accounts or investing in CDs, to optimize their funds, with CDs offering a low-risk option for growing funds.
- To enhance the overall management of one's personal-finance, it is recommended to compare the advantages of savings accounts, money market accounts, and CDs, ensuring a well-rounded approach to handling finances, including emergency funds and long-term investments.
