Certificates of Deposits (CDs) Explained

Written by
David Mully
Read Time: 6 minutes

CDs are important tools for personal financial planning. The following short items summarize some of the most important things to know about them.

Profit by Choosing Your CD Wisely

Submitted on December 8, 2006

If you're disappointed with the earnings on your savings account, consider a certificate of deposit. A CD is insured, just like your savings, but rates are higher, giving you more bang for your buck. Since there are several different types to choose from, it's important to know what you're getting before you hand over your cash.

Certificates of deposits (CDs) come in many shapes and sizes. To make the most out of your savings dollars, it pays to learn the available options.

All CDs require that you leave your money invested for a specified period of time. That's a small price to pay, however, for the benefit of higher interest rates. In general, the more you invest and the longer the term, the more money that you'll earn.

Types of CDs

CDS come in a variety of styles. Here are a few types to choose from.

Traditional: Traditional CDs pay a pre-determined interest rate. Your deposit earns a fixed amount of money over a specific term. However, there are stiff penalties for early withdrawal.

Callable: The bank can call (redeem prior to maturity) this type of CD if interest rates drop. There are restrictions on how soon the bank is allowed to do this and reissue a new one at a lower rate. The callable CD's advantage is that the initial interest rate will be higher than that of a traditional CD.

Brokerage: A CD issued by a brokerage company rather than a bank or credit union often pays a higher interest rate. However, you'll have to have an account there to be eligible.

Bump up: Bump-up CDs allow you to request an adjustment in the interest rate. This is something that you might consider if rates begin to rise. There's always a price to pay, though: the initial interest rate may be lower than the rate on a traditional CD.

Liquid: You can withdraw money from a liquid CD during the term without penalty. What's the trade-off? With a liquid CD, the interest rate will be lower than that on a traditional CD. There also may be limits on when you can take the money and how many times you can do it.

A CD is a great savings account if you don't need your money at a moment's notice. Once you understand the choices, you can choose the one that most aligns with your financial situation.

Savings Tips: Explore Certificates of Deposit

Submitted on April 7, 2007

In the music world, CDs (compact discs) are becoming a thing of the past, thanks to downloadable music. In the financial world, CDs (certificates of deposit) are still a reliable tool that will always be stylish.

For the first time since the Great Depression, Americans are spending more than they save. According to the U.S. Commerce Department of Economic Analysis, Americans have a negative savings rate of .05 percent. Many continue saving, but they're spending more than they're earning by using either accumulated wealth (home equity, 401(k) funds) or credit cards.

If you're looking to return to a positive savings rate, consider the benefits of a certificate of deposit ("CD").

Why people like CDs

With their low-risk and guaranteed principal, CDs are an investment choice for people who want to avoid the roller coaster ride of the stock market. You invest a set amount of money for a certain time period-six months, one year, five years, for example. When that time period is over, the CD has reached its maturity date, and you receive your principal, plus the accrued interest. Certificates of deposit can be redeemed at any time; but if cashed before the maturity date, you will have to pay an "early withdrawal" penalty.

On paper, CDs seem pretty straightforward. But there are a couple of items that you need to watch out for before you make an investment:

  • Callable CDs can be "called" by a broker before they mature. If this happens, you get back the full amount of your original deposit, plus any unpaid accrued interest.
  • Know your maturity date. Many people are unaware when it's time to rollover the certificate of deposit or redeem it for cash.
  • A financial institution's federal deposit insurance is limited to $100,000 per depositor. Check with the lender to make sure that they have such a policy.
  • If you choose a variable-rate CD, know when the rates will adjust and by how much.
  • See if there are any special features, such as death benefits, which allow heirs to cash the CD in the event of your untimely demise.

If you spend money like crazy, try spending some time shopping for a certificate of deposit. The CD is a financial tool that offers plenty of rewards with minimal risk, and could get you back in tune with the financial harmony of savings.

Shopping for a Certificate of Deposit

Submitted on March 28, 2007

Certificates of deposit (CDs) offer healthy yields at virtually no risk-an ideal combination for many investors. While the CD concept sounds like a no-brainer, choosing the right option among many requires discipline and organization.

Finding the best certificate of deposit (CD) is only slightly less complicated than shopping for a new car. CDs have many variables, and some are as confusing as engine displacement and torque ratings. Get organized about your CD search now, so that you won't end up with a lemon later.

CDs are offered by online and traditional banks, savings and loans institutions, credit unions, and brokerage firms. In most cases, your deposit will be insured up to $100,000 by the FDIC. Double check this by asking your banker directly.

CD Variables

Start your comparison-shopping by creating a system to record the information you collect. You could use a handwritten chart or a spreadsheet with a column for each CD you want to compare. Ultimately, you'll want to review and compare the following six variables for each certificate of deposit:

  • Minimum deposit. Typically, a higher minimum deposit requirement translates into a higher interest rate.
  • CD term. CD terms vary from a week to several years. In a normal yield curve environment, longer terms usually mean higher interest rates. In recent months, however, short-term interest rates have been quite strong. You'll have to compare the differences between shorter- and longer-term rates to decide which period makes the most sense for you.
  • Annual percentage yield (APY). CDs usually have a stated interest rate and an APY rate-a higher APY means more earnings power. Don't get distracted by the other rate provided-it doesn't take into account how often the interest is compounded and therefore should not be used for comparison purposes.
  • Rollover policy. Before you lock your money into a CD, find out what your options are once it matures. Your options at rollover may be restrictive, particularly if you're working with an online bank.
  • Early withdrawal penalties. Early withdrawal will prompt the bank to assess a penalty, thus reducing your yield.
  • Account fees. The bank may also assess account fees; these too will reduce your yield.

You may not be able to test drive a certificate of deposit; but researching and comparing these variables is the next best thing.

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