A certificate of deposit is a type of savings instrument that is typically offered by banking institutions and credit unions. A certificate of deposit, which is also known simply as a CD, allows investors a safe place to invest a portion of their money for a set period of time.
CDs are similar to traditional savings accounts (or other fixed income accounts) in that they are virtually risk-free. As long as your investment does not exceed the limit dictated by the FDIC your funds are fully insured.
CDs are different from savings accounts in that they are investments that have fixed, clearly defined terms. An investor agrees to invest their funds with a bank for a specific period of time in exchange for an interest rate that is generally higher than they would receive in a normal savings account. Since certificates of deposit are intended to be held until maturity the investor will incur additional fees and/or penalties should they need to withdraw their fund before they completely mature.
CDs are common investments used by people who want a safe, non-risky way to earn additional income. As the investment earnings, and the principle invested, are completely guaranteed by the Federal Deposit Insurance Corporation (FDIC) CDs make a wonderful option for elderly individuals that want to supplement their retirement portfolio, parents that are saving for their children’s education, or anyone else that does not want to put any of their money at risk.
There are two basic types of CDs; mall and jumbo. Investments of less than $100,000 are generally considered ‘small CDs’ while CDs in excess of this amount are deemed ‘jumbo CDs’. Since jumbo CDs require a large minimum investment they typically earn slightly higher interest rates. Regardless of the type of CD purchased, the investor generally instructs the bank to either periodically mail them a check for the earned interest or to transfer it into a checking or savings account of their choice.
Before electing to invest your money in any CD there are a few things you need to carefully consider.
• Is the CD Callable? – Many banks will add a call feature that protects them from paying the investor an amount that is significantly more than the current interest rates. If, for example, you have a callable CD that is paying 4%, and the overall interest rate falls to 2%, the bank can call your CD, forcing you to either reinvest your money at the lower rate or to terminate the investment completely.
• Automatic Renewal – Take a few minutes and determine whether or not the bank has agreed to notify you as your CD reaches maturity. An investor is typically given a small grace period of approximately ten days in which to either withdraw their funds or to reinvest them. If no action is taken the bank can automatically renew the CD; sometimes at unbelievably low interest rates.
Certificate of deposits provide a safe place to invest your money. If protecting your principle, while simultaneously earning a slightly higher rate of interest, is important to you, consider investing in a certificate of deposit.