An Introduction to Certificates of Deposit

certificate of deposit vaultA CD is a special type of deposit account with a bank or financial institution that typically offers a higher rate of interest than a regular savings account. For consumers and investors, CDs are a low-risk investment; for banks, they are a debt instrument. Banks offer the higher rate of interest to the investor as compensation for lending the bank money.

The account is time-sensitive, meaning that the investor is prohibited from removing money from the CD before a certain amount of time has lapsed. This predetermined term of time (also referred to as the CDs maturity) is set in an agreement between the investor and the issuing bank. When the entire term has expired, the CD is fully matured. If the investor decides that he/she want to withdraw money from the CD before it is fully matured, they can do so but at the cost of a penalty by the bank.

Pros

pros

  • They are FDIC insured investments (for up to $100,000).
  • The investor can determine the predicted amount of earnings at the initial time of deposit.
  • It is low-risk and requires little involvement for the investor; ideal for individuals who wish to cultivate their financial assets safely (albeit at a relatively low-yield) over the course of their lifetime.

 

Cons

cons

  • If for some reason the investor needs to access money in the deposit, they will incur a penalty for doing so.
  • If the investor chooses to extend the length of the CDs maturity in order to receive the higher rate of interest, he/she gives up the ability to withdraw money and relinquishes his/her power to use the capital for other purposes.

 

CD Quick Facts and Tips

  • A CD is a savings certificate entitling the bearer to receive interest.
  • CDs bear a maturity date, a fixed interest rate and can be issued in any denomination.
  • CDs are generally issued by commercial banks.
  • CDs are almost always FDIC insured.
  • The term of a CD can range from one month to five years.
  • CDs are a good place to put extra money for relatively short amounts of time.
  • CDs are considered a safe investment, but their low interest rates mean your money grows slowly.
  • You must pay penalties if you withdraw your money before the CD has fully matured.
  • All gains from CDs are taxable as income, unless they are in a tax-deferred (IRA) or tax-free (Roth IRA) account.
  • “Small CDs” is the term used for CDs of less than $100,000; “large CDs” or “jumbo CDs” refer to ones worth more than $100,000.
  • A CDs interest rate increases in proportion to the amount of time the term has been set for.

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