What is a Certificate of Deposit?
A certificate of deposit (CD), also known as a time-deposit account, is a fixed-term investment offered by financial institutions. As a depositor into a CD, you are essentially lending money to your bank or credit union for a fixed amount of time in exchange for an interest rate that yields a higher return than the average savings account. The balance on your CD remains fixed for the term of that CD, which typically ranges anywhere from 6 months to 5 years. Under the terms of a CD, you are not allowed to withdraw money from the account without penalty. If you have a 1-year CD, for example, you agree to deposit and not withdraw your principal for the entire year; when the CD term ends, you can withdraw your principal and the interest earned on your deposit.
When Should I Invest in a Certificate of Deposit?
In years past, a CD was considered one of the better investment options on the market. Leading up to the stock market crash in September 2008, some financial institutions were offering rates as high as 5% interest over the term of a CD. However, average CD rates nowadays are significantly lower; the typical CD rate now offers a less-than 1% return.
Even though interest rates are at an all-time low, there are still a few benefits to depositing into a CD. Unlike many other investment options, CDs are federally insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, meaning that any money deposited into a CD is protected should the banking institution fail.
CDs also offer significantly higher rates than a typical savings account, and because of the strict withdrawal terms on these accounts, CDs can also help savers remove the temptation to spend or withdraw their savings.
Comparing CD Rates
Before you purchase a certificate of deposit at your bank or credit union, you should search around the market for the financial institution offering the highest return on investment. Many online banks offer higher-than-average interest rates on their certificate of deposits; rates on CDs may also increase steadily in the next few years.