A certificate of deposit is a safe, income-generating investment that is insured by the Federal Deposit Insurance Corp. up to $250,000. Depending on which financial institution you bank with, your bank or credit union’s CD products might also be referred to as:
- Term certificates
- Term CDs
- Savings certificates
- Time deposits
A number of different types of CDs are available, as well as various strategies to maximize your earnings. For example, a GOBankingRates study recently found that 96% of Americans aren’t taking advantage of the CD laddering strategy, which can provide higher returns than savings accounts while still offering federal insurance. So before you tie up your extra cash in a CD, learn about all the options to find out which CD might be right for you.
Think of certificates of deposit as interest-bearing savings accounts — with a few key differences. A CD is sold by financial institutions like banks, brokerage houses and credit unions. CDs are considered a low-risk investment because they are generally FDIC-insured up to a high limit and because, when held to the end of the term, a CD will return the full amount of the original investment plus interest.
Because of the way they are structured, CDs can be ideal if you have extra cash that you won’t need for an extended period and want to earn more interest than you would from a money market or savings account, without having to risk the principal investment. Here’s a look at some of the basic characteristics of CDs, along with information that can help you choose the best CD account for you.
This guide to certificates of deposit will cover:
- What Is a Certificate of Deposit and How Does It Work?
- Different Types of CDs at a Glance
- What Are the Benefits of CDs?
- Types of CD Strategies
- When Does a Savings Account Make More Sense?
- Alternatives to CDs
- Is a CD Right for You?
What Is a Certificate of Deposit and How Does It Work?
A CD is a type of time deposit, meaning you agree to leave your money with a bank or other financial institution for a specified period of time. In exchange, your bank agrees to pay you interest and return your principal at the end of the time period. Typically, a CD matures between six months and five years, although CDs come in shorter variations (like three months) as well as longer ones (like 10 years).
A CD differs from a traditional savings account in two primary ways. First, a savings account doesn’t usually have the withdrawal restrictions that a CD does. You can access the money in your savings account whenever you’d like, subject to federal requirements that prohibit more than six transactions of certain kinds per month. A CD, on the other hand, charges significant penalties if you take your money out before maturity, often ranging from a few months’ of interest to all of the interest you’ve earned. Second, a CD will often pay more in interest than a savings account. This is not always the case, as online savings accounts are now quite competitive with CD rates. But in many instances, you can earn more by locking your money away in a CD than you can by investing in a more liquid savings account.
For example, over the past 10 years, the average national rate on a 12-month CD has ranged between a low of about 0.19% to a high of about 1.27%. Over that same time period, the national average savings rate has ranged from about 0.06% to 0.22%. There are plenty of accounts that pay higher-than-average rates, but comparatively speaking, you can often earn more in a CD than you can in a savings account.
Long-term CDs typically pay higher rates than short-term CDs, but there’s a catch: If rates go higher while you’re invested in a long-term CD, you’re essentially stuck with the rate you have until maturity. Although you can take out your money at any time, you’ll get hit with the early withdrawal penalty, which varies from bank to bank.
Here’s a look at CD rates at 10 banks:
|Bank||APY for 12-Month CD||APY for 60-Month CD|
|Barclays Bank Delaware||2.70%||3.05%|
|Capital One Bank (USA)||2.50%||2.90%|
|Marcus by Goldman Sachs||2.60%||2.90%|
|First Internet Bank||2.75%||3.02%|
|SunTrust Bank||2.26%||2.30% (58-month CD)|
|Rates are updated weekly.|
Different Types of CDs at a Glance
Almost as many types of CDs exist as there are types of savers. Use this guide to help narrow your search and find the type of CD that will best suit your financial goals. Here are the types of CDs, including certificate of deposit pros and cons:
|Types of CDS|
|CD Type||Key Features||Factors to Consider|
Term lengths, rates and minimum deposit requirements vary by institution and also depend on factors such as the federal funds rate.
Also See: 9 Tips for Choosing a CD Account
What Are the Benefits of CDs?
The main benefits of a CD are income and safety. Not many investments come with a government guarantee, and CDs carry insurance of up to $250,000. This makes CDs an excellent choice for investors who absolutely need to protect their money. Some CDs also pay a very competitive rate, especially when compared with other guaranteed accounts like savings accounts.
As with most investments, there are various strategies you can employ when investing in CDs to try to maximize your return while still preserving the safety of your principal. One common CD investment strategy is laddering.
Consider These Options: 10 Best CD Accounts of 2019
Types of CD Strategies
If you’re looking for a little more bang for your buck when it comes to investing in CDs, consider a CD investment strategy. Rather than simply buying a single CD, you can invest in a range of CDs to help you achieve your investment goals. Three strategies in particular, the CD ladder, CD barbell and CD bullet, offer different ways to enhance the return on your CDs. They can also help reduce certain risks that affect CDs, such as interest rate risk and liquidity risk.
If you’re unsure about how long you want to tie up your money in CDs, or if you believe interest rates will climb in the near future, a CD laddering strategy might be right for you. CD laddering is a way to keep your investment somewhat liquid and can result in higher growth rates.
To create a CD ladder, simply divide up your total investment into smaller sums, buying CDs of varying terms. For example, instead of buying one CD worth $30,000, you might buy three $10,000 CDs — one each at six-, 12- and 18-month terms. By doing this, one-third of your money becomes liquid every six months.
When one CD matures, you can either use the cash for something else or reinvest it in another 18-month CD, keeping the ladder strategy going. In addition to added liquidity, this strategy also allows you to maximize interest rates because, upon the second round, you are always investing in longer-term CDs.
You can do this in any combination with any term lengths. If liquidity is of utmost importance, use shorter maturities, such as three-month terms. For less liquidity but higher rates, go for intervals of one year or higher.
You can also use CD strategies that help combine greater liquidity with greater interest rates. One of these strategies is a CD barbell: You put half your investment into short-term CDs and half into long-term CDs. With this strategy, you’ll have some flexibility with the short-term investments and get better interest yield with the longer-term accounts. Overall, you’ll get a medium yield average.
Another strategy is a CD bullet, in which you buy CDs that have the same maturity date at different times. So the first year, you buy a 10-year CD, the second year you buy a nine-year CD, and so on. With the CD bullet strategy, you minimize the risk of missing out on higher interest rates by staggering your purchase dates. A CD bullet strategy could be useful for maximizing savings for a specific goal with a predetermined payment date, such as college tuition or retirement.
Check Out: The 10 Best Short-Term Investments for 2019
When Does a Savings Account Make More Sense?
A CD can be a tempting option for an emergency fund, because emergencies don’t happen very often for most people and CDs typically pay higher interest rates than savings accounts. However, emergencies, by their very nature, are unpredictable. If you suddenly get hit with a $1,200 car repair or a $3,000 medical bill, you don’t want to have to break your CD and pay interest penalties just to pay your bills. For the most part, emergency funds are better kept in more liquid savings accounts. Many online high-yield savings accounts have yields that rival the best CDs anyway, so keeping your emergency funds liquid usually makes more sense.
Related: 10 Best Savings Accounts of 2019
Alternatives to CDs
CDs aren’t the only savings instrument available; many alternatives might better suit your particular needs and goals. Here are a few common alternatives to CDs:
|Alternative Options to CDs|
|Alternative Account Type||Key Differences From a CD||When To Use It|
|High-yield savings account|
|Money market account|
|U.S. Series I savings bonds|
|U.S. Series EE savings bonds|
Find Out: What Is a Money Market Account?
Is a CD Right for You?
When shopping for CDs, you’ll want to factor in more than just the interest rate. Before you open a CD, make sure it’s the right one for you by first answering a few important questions:
When will you need this money?
Most CDs come with heavy penalties for early withdrawal, so don’t let a higher rate seduce you into tying up money you might need soon. If there’s a chance you’ll need the money, choose a shorter term or a CD without a penalty for early withdrawal.
Do you have an emergency fund?
Make sure you aren’t using emergency funds for the CD. If you find yourself in a real emergency without dedicated emergency funds, you might end up resorting to using a credit card for your immediate expenses — and losing money by carrying a balance or having to take a cash advance.
Does the CD automatically roll over?
If the answer is yes, make sure you take actions to remind yourself of the date your CD matures. If you forget, the bank will roll the CD over automatically, and you won’t be able to access your money for another term.
Do you think interest rates will rise or fall?
The vast majority of CDs have a fixed interest rate for the life of the term. So, if you believe rates will rise in the future, perhaps you should accept a shorter term — and likely, a slightly lower interest rate — so you can renew to a higher rate later.
Can you accept loss on inflation?
If you are investing in a long-term CD, remember that there’s always a chance that inflation outpaces your interest. At that point, you’re actually losing buying power. Decide whether you are comfortable with that risk before proceeding with a long-term CD.
Keep reading to see nine safe investments with high returns.
Terence Loose is an award-winning writer who has covered topics ranging from finance to travel, fitness and education.
John Csiszar contributed to the reporting for this article. He has written thousands of articles about financial services after serving for 18+ years in the industry. During that time, he earned his Certified Financial Planner designation, was a Registered Investment Advisor, and earned his Series 7, 63, 65 and Insurance licenses.
More on Investing