What is a CD?

A certificate of deposit, also known as a CD, is a savings product offered by banks and credit unions, which pay a fixed rate of interest if you lock your money away for a set period of time.

As you are agreeing to keep your money with the institution for a pre-determined period, the interest rate on CDs is often more generous than on accounts that enable you to access your money. Unsurprisingly, CDs with longer terms (the amount of time you lock your money away) tend to carry higher interest rates.

In most cases, you’ll pay a penalty if you make a withdrawal from your CD before your product matures (reaches the end of its term). You might, for instance, forfeit a percentage of the interest you have earned.

How do CD Rates work?

When you take out a CD, the rate of interest you receive is normally tied to interest rate decisions made by the Fed. 

When prices for consumers are high and inflation is rising, central banks tend to increase interest rates in an attempt to encourage people to save rather than spend. As a result, interest rates on products such as newly issued CDs will also likely increase. Be aware, however, that this isn’t guaranteed, and CD rates may not rise instantly.

As mentioned above, you’ll need to lock your money away for a set period of time—typically between 3 and 60 months—when you buy a CD.

Although banks and credit unions have different policies on early withdrawal penalties, the amount you pay is often determined by the term of your CD. Longer-term CDs tend to come with higher penalties.

Once your CD has reached its investment term, you can either withdraw your money or reinvest it into another CD.

How Do I Get the Best CD Rates?

Deciding whether or not to buy a CD often depends on if you believe central banks are likely to increase interest rates in the future.

If you believe rates will rise, it might be wise to delay buying a CD until rates have gone down. If the banks are about to cut interest rates, however, it might be a good time to buy a CD and beat upcoming rate reductions by locking in a higher rate.

Buying a CD could also be a good choice if you want a guarantee that you cannot lose money on your savings, as the terms of a CD will state that you will receive a set minimum amount when it matures.

Conversely, a CD might not be appropriate if you may need to draw on your cash during the term of your investment. In this case, you may want to consider a more liquid investment such as an easy-access savings account.

As the terms of CDs vary greatly between different banks and credit unions, it’s essential that you compare as wide a range of products as possible when you’re choosing a CD.

What Are the Types of CDs?

Traditional: This is the most common type of CD and normally comes with a fixed rate of interest, a fixed term, and a minimum deposit.

No-penalty: This type of product will enable you to withdraw your cash without paying a fee. 

Jumbo: These normally have a high minimum deposit requirement and pay a higher return.

IRA: Also known as an individual retirement account, these products can include more than 1 CD, plus other investments. 

Bump-up: These enable you to benefit from any increase the central bank makes to interest rates during the term of your CD. If the rate rises, a bump-up CD enables you to tell your bank you’d like to receive the higher rate.

Set-up: As with a bump-up, a set-up CD enables you to benefit from interest rate increases. However, you won’t need to ask for an increase, as your provider will automatically increase your rate at certain periods.

Add-on CDs: While most CDs restrict you to making 1 deposit, these enable you to make additional contributions. 

Foreign currency: These products link your savings to the value of foreign currencies. Unlike most CDs, they do not offer a guaranteed return.

Brokered: These types of products are available through 3rd parties such as brokerage firms.

Pros and Cons

FAQs

Are CDs safe?

CDs are one of the safest investment options available to investors today. CDs that are offered by FDIC-insured banks are guaranteed by the government itself. CDs allow investors to safely store their savings while also earning a set rate of interest. 

Such guarantees make CDs a safer option than investing in the stock market, where you could lose your entire principal if markets don’t turn in your favor.

Are interest rates going up?

The Fed has increased interest rates regularly since March 2022 from 0.5% to 2.5% to help bring the inflation rate down. It’s stated that interest rates may continue to rise in the future, especially if the inflation rate keeps increasing. This will likely result in an increase in rates on most savings products.

Why choose a CD vs a high-yield savings account?

Although savings accounts often provide more flexibility over when you can access your money, the most competitive CDs pay a far more attractive rate of interest than a conventional savings account. And, although you may potentially earn higher returns on the stock markets, there is also a risk that you could lose your entire investment.

How much will a $5,000 CD make in one year? 

If you place $5,000 in a 12-month CD paying the current interest rate of 0.22% (the current CD average), you would earn $11 in 1 year.

How do I choose a CD term?

When selecting your CD, you should first consider your plans for the money. If you need access to the funds for a specific deadline, you should choose a term that will enable you to tap into your cash by that date. However, you may receive a better rate if you can afford to lock your money away for longer.