Banks offer a variety of accounts that you can use to hold your money and even earn some interest. CD stands for certificate of deposit, which is a type of account you can open to hold your money. If you're looking for a low-risk investment, and aren't concerned about achieving the highest rates of return, it might be a good idea for you.
What is a CD Account?
CD stands for certificate of deposit. It's basically a type of fixed-term savings account with a bank or credit society. In return for depositing your money for a predetermined term, the bank promise to pay you a set interest rate . This gives you the security of knowing how much you're going to earn, and gives the bank the security of knowing it has your money until the CD matures. The more money you put in, and the longer you promise to leave it in the CD, the higher your interest rate. For example, putting $10,000 in a five-year CD will get you a higher interest rate than putting $500 in a three-month CD.
Look Out for Bells and Whistles
Many banks offer CDs that have special features that can make them more or less attractive to investors. For example, some banks offer a bump up CD, which gives investors the ability to raise the interest rate on the CD to the current market rate once or more during the term. Another beneficial feature is a liquid CD, which allows you to remove a certain amount of your investment without penalty, as long as you still have a certain minimum balance. However, these benefits are often offset by a slightly lower interest rate. Alternatively, banks might issue CDs that are callable after a certain period of time, which means that the bank can require you to cash it in early if it doesn't like the terms. For example, if interest rates plummet, the bank could require you to cash it in because you're getting a much higher rate than the market is currently paying. But, if interest rates rise, you would be stuck with the lower rate.
What are the Advantages of a Bank CD?
CDs generally pay higher interest rates than other deposit accounts, like savings and checking accounts, because you promise not to take out your money early. That way, the bank can count on having your cash available to lend out to other customers in the meantime. Plus, CDs are covered for up to $250,000 per bank by the Federal Deposit Insurance Corporation in case the bank goes under. So, there's no risk that you'll lose your money, which cannot be said for other types of investments like stocks. People tend to choose a CD then they know they won't need your money for a while, desire predictable returns, and don't want to risk losing any of their investment.
What are the Disadvantages of a CD Account?
The biggest downside to using a CD is that you can't access your money before your term is up. If you do, you get hit with big penalties. While every bank has different conditions, taking your money out early will typically cost you 90 days' worth of interest on CDs with terms of less than one year or 180 days' worth of interest on CDs with a term of one year or more. And, if you haven't earned at least that much interest, most banks will dip into your principal to pay the penalty.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."