If you’re new to investing or saving, you might have been told to open a certificate of deposit, or CD.
CDs arelow-risksavings products that let you invest a specific amount of money for a set period of time, or term. Longer terms, like three– or five-year CDs, generally offer higher annual percentage yields -- though in our current climate of rising rates, many shorter-term CDs offer high APYs as well.
CDs are great for new investors if you have a more modest amount to work with or don’t need immediate access to your invested money. Here’s what to know about CDs, how they work and the different types available.
Read more:CD Rates Remain Between 4.00% and 5.00% as Inflation Cools
What is a certificate of deposit?
A certificate of deposit, or CD, is a savings option typically offered by a bank or credit union. You agree to deposit a lump sum of money, known as the principal, for a fixed period, or term.
In return for locking up your money, the institution typically agrees to pay you a fixed interest rate.
You’ll often earn a higher APY with a CD than you would from a typical savings account, and there’s less risk involved than with other investments like mutual funds.
On the downside, CDs aren’t as flexible as savings accounts. If you need to access your money before the term ends, known as the CD’s maturity date, you’ll often have to pay an early withdrawal penalty equal to a few months of interest.
The longer the terms of your CD, the more interest you’ll generally earn. CDs have terms starting atone month, ranging up to five or 10 years.
How does a CD earn interest?
The interest rate tied to a CD is called itsannual percentage yield, or APY. The APY on your CD is usually locked in when you buy it.
CDs earncompound interest. Usually monthly or daily, the bank will roll the interest you’ve earned into your balance, increasing the principal.
Read more:What Are Step-Up and Bump-Up CDs?
What are different types of CDs?
Along with a traditional CD, where you invest a lump sum for a specific period, there are a variety of CDs with special rules and benefits. For example, an IRA CD gives investors tax advantages for retirement but raises the danger of an extra IRS penalty for early withdrawals.
Among many other CD options, a foreign currency CD exchanges your money for that of another country’s currency until it matures, when it transfers back to dollars. A zero-coupon CD eschews APY and instead guarantees a specific value for the CD when it matures. A no-penalty CD also offers more flexibility, letting you withdraw your funds early without incurring an early withdrawal penalty.
Bump-up CDs let you boost APYs one time if interest rates rise, and add-on CDs let you invest more money during the length of the CD’s term.
Each type has its own rules and requirements, which typically vary by bank and CD term.
Read on:All the Different Types of CDs
How long is the best term for a CD?
It all depends on when you think you’ll need to access your money.
If you’re planning to buy a car in a few years, putting your car-fund money in a three-year CD may be a safe bet. But if your vehicle is on its last legs, don’t tie too much into a CD.
If you’re saving for the distant future and won’t need the money anytime soon, look for the highest CD rate you can find, usually with five-year terms or longer.
And always make sure you have anemergency fundset aside in an easily accessible account.
Read more:Best Five-Year CD Rates
Are CDs insured?
Most CDs offered by banksare insured up to $250,000per issuer, per bank for each account category by the Federal Deposit Insurance Corporation. The CD equivalent issued by credit unions, often referred to as share certificates, are insured for the same amount but by the National Credit Union Administration. Before opening a CD, make sure the financial institution is FDIC- or NCUA-insured.
Foreign currency CDs typically aren’t covered by the FDIC, and some brokered CDs aren’t, either.
What is a CD ladder?
A locked APY is good news if interest rates take a nosedive. But if they go up, you could miss out.
Buying multiple CDs of varying term lengths,known as CD laddering, enables you to take advantage of either eventuality. It also ensures at least some of your money will be available soon should an unexpected need arise.
Where can I buy a CD?
You can find a variety of CD options at traditional banks,online banksandcredit unions.
You can also buy CDs through brokerage firms, which purchase them from the banks. If you buy abrokered CDon this secondary market, you can sell it before its maturity date without incurring a penalty -- but you may have to pay a brokerage fee.
Correction: An earlier version of this article was assisted by an AI engine and it mischaracterized some aspects of savings accounts and higher-risk assets. Those points were all corrected. This version has been substantially updated by a staff writer.
