Certificates of deposit (CDs for short) are one of the safest ways to save and invest your money and generally pay more interest than regular savings or money market accounts. A common mistake many people make is to simply buy a CD at the bank where they have a checking account without shopping around. All CDs are not the same. Banks and credit unions compete for your dollars, so it's to your advantage to do your homework and go where the best deal is.
The Basics of Certificates of Deposit
A certificate of deposit is classified as a fixed-rate time deposit. You receive a guaranteed interest rate when you buy a CD. In exchange, you agree to keep the money on deposit until the CD matures, which may be anywhere from three months to five years. Cashing in a certificate of deposit early incurs a penalty in the form of sharply reduced interest, so you should be reasonably sure you won't need the funds until after the maturity date before you purchase a CD.
Banks and credit unions offer certificates of deposit. Along with checking and regular savings accounts, they are insured by the federal government through the FDIC or the National Credit Union Authority. The earnings from a CD are taxable as ordinary income but they can be included as investments in an IRA or other tax-deferred retirement plan.
Shopping for CDs
At any given time, CD providers offer a range of interest rates on certificates of deposit. Before you start looking for the right CD, it helps to know what things affect CD rates. The maturity is a major factor. Banks want you to leave the money on deposit for as long as possible, so CDs with maturities of several years pay significantly more than short-term certificates. The size of a CD matters, too. A large CD gets better rates, with the best going to "jumbo CDs" of $100,000 or more.
It is very common for small banks to offer premium rates on CDs as a means of luring depositors away from larger financial institutions. If you have enough money to purchase a jumbo CD, you may want to consider a "brokered CD." The broker is a go-between who negotiates on behalf of investors to get top interest rates in exchange for a fee.
Non-traditional CDs
In recent years, a variety of CDs with special features have been developed. These can present opportunities for investors, but some can work to your disadvantage. Variable-rate CDs have a guaranteed minimum interest rate. The bank may pay more if business conditions warrant. However if the guaranteed rate is much below the rate you are being offered, caution is in order. If prevailing interest rates fall, you'll probably receive only the minimum, since that is all the bank or credit union is actually promising.
Some of the non-traditional certificates of deposit are good deals, particularly "add-on" and liquid CDs. An add on CD allows you to put more money into the CD after you purchase it (usually in minimum deposits of $500) and get the same interest rate as the rest of the funds in the CD. Liquid CDs take this a step further and allow you to withdraw limited amounts from an existing CD before its maturity without penalty. Typically these CDs pay interest rates a little less than conventional certificates of deposit but higher than money market accounts.
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