A certificate of deposit is a product that’s offered by financial institutions including banks and credit unions that allows customers to save money for a fixed amount of time and, in return, they earn interest when the period ends. This period of time is referred to as the maturity date. Almost all banks offer CDs, but it’s up to the individual financial institutions to decide how much interest they’ll offer, the maturity period and the fines customers incur for withdrawing the money before the maturity period lapses.
Categories of Certificates of Deposit (CDs)
CDs are categorized into two broad categories: negotiable and non-negotiable. Non-negotiable CDs can only be sold after the maturity period ends. Otherwise, the owners will incur fines that result in lower interest rates.
On the other hand, negotiable CDs, which were first introduced in the 1960s can be sold in the secondary market. CDs that are less than three months old are more appreciable.
- Retail negotiable CDs were first introduced in 1982 by Merrill Lynch and come in denominations of $100,000. Security firms offer the option to buy back the CDs before the maturity date for investors who want to get their money back early.
- Large-denomination negotiable CDs which are the largest negotiation CD market with a domination of $1,000,000 and above. These types of CDs are mostly owned by investment companies and money market funds. However, other financial institutions such as banks, credit unions and municipalities also invest in large-denomination CDs.
- Non-callable vs callable CDs: Most bank-issued CDs are callable, meaning they can't be sold before the maturity date. One advantage of callable over non-callable CDs is that they earn higher interest rates. One disadvantage of non-callable CDs is that you may end up selling them soon after you get your yields because reinvesting the returns may fetch lower interest rates.
Primary vs. Secondary Certificates of Deposits (CDs)
Primary CDs involve an investor purchasing directly from the issuing financial institution whereby they receive a deposit agreement after they make the initial deposit that outlines the terms of the agreement.
On the other hand, the secondary market involves using brokers who purchase the CDs on the investor's behalf. The investors purchase the CDs from banks, other financial institutions or individuals who are looking to get their return on their investment. There are a lot of options to choose from when you purchase CDs from the secondary market because brokers can have all types of CDs.
Considerations When Trading CDs
CDs earn a fixed interest over the agreed period. If you cash in the CD before the maturity date, you incur penalties that put a dent in your initial investment. A viable option would be to purchase no-risk CDs that allow you to make withdrawals any time you want. Brokered CDs are another suitable option because you can sell them to another investor if you want to get your money back.
Primary market CD terms are automatically renewed. This means you have a short time, usually 7-10 days, to withdraw your earnings before a new term begins. If you make a withdrawal after the grace period lapses, you’ll incur fines. They are therefore a good investment if you want to retain your money in the account.
Secondary market CDs are non-renewable. When the CD matures, your issuer deposits your money in your brokerage account after which you decide what you want to do with your money.
Read More: Can I Cash in IRA CD at any Time During Term?
CDs are a safe investment because they earn a fixed interest rate over the agreed period. It's, therefore, possible to estimate your earnings at the end of the maturity date.
Some brokered CDs earn simple interest that's not compounded. Secondary CDs can earn higher returns but you may also incur losses when the market dips.
Read More: How to Value a Certificate of Deposit
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