If you have cash in a savings account that you don't need for a while, consider depositing it into a certificate of deposit (CD). The interest rate will be higher than in a savings account. Remember, where savings are concerned, interest is the name of the game.

It's nice to have money in the bank. It's even nicer to have that money earning money. A certificate of deposit (CD) offers a safe way to let your cash work more effectively for you than a savings account.

A CD pays a fixed interest rate over a specified length of time. That rate will be higher than you'll earn on a simple savings account. Your bank or credit union is willing to pay you more in interest because they're guaranteed the use of your money for an uninterrupted period of time. If you withdraw your cash before the term is up, however, you'll be hit with penalties.

CD Basics

The longer the term of a CD, and the larger the initial deposit, the higher the interest rate. Terms generally range from 6 months to 5 years. During that time, you won't have access to your money. You will, however, have the option of drawing out the interest as it's paid.

Let's say you put $1,000 in a CD for one year at an annual percentage yield, or APY, of 5 percent. At the end of the year, you'll have $1,050. Fifty dollars may not sound like a lot, but leaving it in a savings account with a 2 percent APY will earn only $20.

Another great asset of CDs they're insured just like the money that you'd put into a savings account.

Know what you're getting

Certificate of deposits offer a variety of features. Some have "call" options that allow the bank to call it in if interest rates drop. Some CDs even have variable interest rates. Before you sign on the dotted line, ask questions, get answers and fully understand the CD that you're buying. You'll need to know

  1. When the CD matures
  2. The interest rate and whether it changes
  3. Whether the CD can be called, or terminated early
  4. Penalties for early withdrawal
  5. How and when you'll be paid

A certficate of deposit is one of the safest investments you can make. Don't let your cash grow moldy in a savings account; make better use of it with a CD.

Also see our section about finding the best cd rates.

Other CD Rates Resources

Money Market Accounts

Finding the Best CD Rates

Certificates of deposit (CDs) offer the best of both worlds-reliable returns with very little risk. But not all CDs are the same. This primer will help you get the most bang for your buck. Advertisements for certificates of deposit (CDs) are everywhere. If cash is burning a hole in your pocket, buying one could provide a safer alternative to riskier investments like stocks. By learning how to obtain the best rates, you can maximize your return.

Higher rates with brokers

Brokered CDs-those sold by brokerage firms as opposed to banks-generally offer the best CD rates. But you may have to spend $10,000 or more to buy one, and they're not all FDIC insured. Although CDs rarely fail, you'll be assuming slightly more risk if you buy one of the uninsured variety. If safety is your primary concern, ask your broker for one that's FDIC insured and review the purchase paperwork for FDIC disclosures before you sign. The broker's commission will also be subtracted from your total investment amount. Crunch the numbers first to determine whether you'd actually be better off with a brokered CD or one from a bank.The minimum investment amount may tempt you to tie up more money in a brokered CD. Brokers will assure you that you can easily sell these investments on the secondary market if you need to make an early withdrawal. Don't believe it. Your ability to sell (and make a profit) will depend largely on market conditions at the time, and no broker has a crystal ball.

Pay Attention

Unless you specifically advise otherwise, most banks and brokers will automatically renew your CD at maturity. If interest rates are rising, you could find yourself locked in at the old rate and unable to capitalize on newer offerings. You'll probably receive a notice from your bank or brokerage firm when your CD is about to mature; but don't depend on them to keep track of that investment for you. Make a note on your calendar to contact your bank or brokerage firm at least 30 days prior to maturity.

Tips for success

When you buy a CD, you're giving the seller permission to invest your money for a set period of time. If you agree to a longer investment period, they'll usually (but not always) reward you with a higher rate. If you can afford to part with your money for a while, buy a long-term CD in order to maximize your return.CD terms vary. Read newspaper ads, visit local banks and credit unions, and surf online for the best deals. In general, they're simple, convenient, and safe. Although they don't offer the upside potential of a more aggressive investment like stocks, they don't carry the risk, either. Research all your options in order to find the best rates, and you'll be smiling all the way to the bank.

Determining CD Rates

Several factors determine how banks and credit unions set interest rates on CDs (certificates of deposit). Learn those factors and you can find the best rate for your savings.

To most folks, the rise and fall of interest rates on certificates of deposit (CDs) seems pretty random. You might imagine a group of bankers sitting around a table, flipping coins to decide if a new, one-year certificate of deposit should pay more or less than it did yesterday. While setting CD rates is a game of sorts, it's not one that's left entirely to chance.

Institutions that issue these financial instruments consider several factors when setting their CD rates, including

    • Length of the deposit.

CD issuers maintain a rate schedule, offering different rates for longer and shorter maturities. In a normal rate environment, a longer maturity yields a higher interest rate. This encourages depositors to leave money on deposit for a longer period of time.

    • Amount of the deposit.

Because issuers prefer large deposits over small ones, most financial institutions will pay higher CD rates on deposits that exceed a stated amount.

    • Competitive strategy and profitability.

Bankers can lure in more customers by raising their interest rates just above where their competition is priced. Alternatively, some banks or credit unions may choose not to engage in competitive pricing.

Profitability for the bank or credit union is another factor influencing CD rates. Credit unions, which are not-for-profit institutions, often have lower expenses and can therefore offer higher interest rates.

    • Interest rate outlook.

Expected changes in interest rates might also affect CD rates. If banks and credit unions believe that market interest rates will drop, rates on longer-term certificates of deposits will move closer to those offered for short-term deposits. This is done if the issuer believes it might save money by discouraging long-term deposits. Conversely, if rates are expected to go up, long-term CDs would be priced higher to encourage depositors to lock in those funds before rates rise.

Finding the best CD rates

Finding the best rates for your savings takes a little legwork. Spend some time shopping around-visit your bank or credit union and run some searches for online banks, like ING Direct. Gather quotes and compare them based on maturity length and minimum deposit requirements. It's also a good idea to know what the investment community is saying about the outlook for interest rates, and how this might affect those being currently offered. Don't try to time the market perfectly-the experts can't even do this. Just be aware of why, for example, the short- and long-term rates might be very similar.

CD investing is a great way to take some of the risk out of your portfolio. Once you lock in your deposit, you need only sit back and wait for your interest payments, even as those bankers continue to flip their coins.

Published on February 14, 2014