What is a Certificate of Deposit

When it comes to saving money, most people go right to traditional savings accounts. But if you could earn more interest while still keeping your money safe, wouldn’t you do it? That’s where Certificates of Deposit (CDs) come in. CDs, also known as share certificates of deposit,  are a low-risk, high-reward option for those looking to grow their savings without taking on the risks typically associated with investing.

Let’s take a closer look at CDs and how they work.

What is a Certificate of Deposit?

A Certificate of Deposit is an account offered by financial institutions that locks money in for a fixed period of time in exchange for a guaranteed interest rate. Unlike a traditional savings account, where the holder can withdraw money anytime, a CD requires the owner to leave their funds untouched for a set term, typically ranging from a few months to several years. Once the term ends (known as the maturity date), you get your initial deposit back along with the interest you’ve earned.

Why choose a CD over a savings account?

Both CDs and savings accounts allow you to earn interest on your money, but there are important distinctions between the two. Here are some key reasons you might choose a CD over a traditional savings account:

• Higher interest rates than regular savings accounts.
• Predictable growth throughout the term.
• No temptation to spend while money is locked in.
  
  

Why are CDs considered a safer investment?

CDs are one of the safest investment options available to the savvy saver. Here’s why.

• Insurance. CDs issued by banks are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor per bank, and CDs issued by credit unions are insured by the National Credit Union Administration (NCUA) for the same amount. This means that, even if the bank or credit union fails, your money is protected.
• No market risk. Unlike stocks or mutual funds, CDs are not subject to market fluctuations.
  
  

Why are there penalties for withdrawing funds early?

Banks and credit unions usually impose early withdrawal penalties to discourage people from breaking their commitment by withdrawing funds before maturity. These penalties serve two purposes:

1. 1. They help financial institutions manage their funds effectively. Since banks and credit unions use CD deposits for loans and investments, unexpected withdrawals can disrupt their financial planning.
   2. They encourage disciplined saving. The penalty ensures that people only invest money in a CD if they’re truly committed to leaving it untouched.
      
      

Factors to consider before opening a CD

Before you commit to a CD, here are a few important factors to keep in mind:

• Interest rates. It’s important to compare rates from different banks and credit unions to ensure you’re getting the best return.
• Term length. Choose a term that aligns with your financial goals.
• Early withdrawal penalties. Understand the penalty structure in case you need to access your money before the maturity date.
• CD laddering strategy. If you want to maximize returns while maintaining flexibility, consider a CD laddering strategy, which involves investing in multiple CDs with staggered maturity dates to access funds at regular intervals.
• Inflation risk. If inflation rises faster than your CD’s interest rate, your purchasing power may decrease. Consider this before locking in a long-term CD at a lower rate.

Is a CD right for you? 

A CD can be the right choice for people who want a safe and predictable way to grow their savings. It can be ideal for:

• People who don’t need immediate access to their money.
• Individuals who want a higher interest rate than a savings account offers.
• Investors looking for a risk-free place to store funds.
  
  

If you need liquidity and easy access to your money, a savings account or a money market account may be a better fit.