Table of Contents
- A Certificate of Deposit (CD) is a timed account that earns interest over time. Its terms can range from one month to ten years, with longer terms usually offering better interest rates.
- Different types of CDs exist, including Standard, Liquid, Variable, Jumbo, Step Up, Trade Up, and Callable, each with unique characteristics and advantages.
- CDs are secure investments with an auto-renew feature, but they limit immediate access to your funds.
- Before investing in a CD, it’s recommended to research and consider shorter terms initially. Strategies like diversification and having CDs with varying maturity dates can be beneficial.
Congratulations on your savings! Now, it’s time to learn how to invest wisely. Remember, never risk more than you can afford to lose. Consider nearly risk-free options like a Certificate of Deposit (CD).
A CD is a timed savings account with restricted withdrawals until its maturity date. Early withdrawals are possible but may result in penalties. Hence, avoid them unless necessary.
How Does It Work?
Understanding how a CD works is really pretty simple. Banks or Credit Unions offer CDs with different terms, which will earn interest on the funds while they are in the CD accounts. Once the maturity date is reached you can decide to cash out the CD or roll the principal and earned interest into a new investment account.
Before you decide to put your money into a CD it is important to know that you do not expect any major expenses to come up during the CD term. You do not want to need cash and not readily be able to access it or be penalized for doing so. Once you decide you want to invest in a CD, you need to decide what term is going to work best for your financial situation and investment needs or desires.
CD Terms
CDs come in a variety of terms. You can have a short term CD one month to six months. Most CDs are a minimum of a year. Typically the longer the term of the CD the better the earned interest rate on the investment. Standard CD terms are six month, one year, two years, and up to five or ten years. Some CDs require a minimum deposit, but not all. So even if you do not have a large amount of money to invest there is a right CD for you.
Types of CDs
- Standard CD: The standard CD investment has a fixed term with a fixed interest rate. You deposit $X and after the term is up, you will have earned $X in interest. The rates will vary by institution.
- Liquid CD: Also known as a No-Penalty CD: This is like a standard CD however because you are able to retrieve your funds the investment during the term it will earn a lower interest rate.
- Variable CD: The Variable CD investment has a fixed term, but the earned interest rate will vary. The interest rate would change due to different market conditions that would cause the rate to increase or decrease. This investment has more risk than the standard CD because the end earned interest could be less. You would not lose the principal amount like you could in other investment tools, so you principal is still safe and earning interest, your just may no earn as much interest as you had hoped.
- Jumbo CD: It is exactly what it sounds like, if you have a large amount of money to invest, you could consider a Jumbo CD as it earns more in interest than a standard or variable CD.
- Step Up CD: A Step Up CD has a step up plan for the interest rate on the CD. During specific times during the term of the CD the interest rate will increase. A Step Up CD Provides investors with a higher earned interest over the course of the CD term.
- Trade Up CD: Also known as a Bump Up CD. If CD rates have increased a Trade Up CD offers investors a one-time chance to unlock their current CD interest rate and lock in at the current rate.
- Callable CD: A Callable CD is where the issuing institution can call back (terminate the CD) after a protected period of the investment ( say 6 months ) but before the CD’s maturity date of 1 year. It can be good or bad depending on what happens in the market. Unless you plan on tracking CD rates on a routine basis this type of CD may not be the best option for you, especially if you are just starting to invest in CDs.
For further information on current CD rates, check out our full guide on the best CD rates here.
Pros and Cons of Investing in CDs
Pros
- Secure investment – you do not have to worry about the principal investment being depleted.
- If you do not renew or move your funds into a new account, CDs have an auto-renew feature. The bank will reinvest your funds into a standard CD; this will keep your investment earning interest for you if you forget to roll your investment.
- You know, give or take, what your earned interest will be after maturity of the CD.
Cons
- If you do not renew your CD the institution may auto-renew your funds into a standard CD, which if that wasn’t your plan you have now lost time to choose your own investment. Be sure to stay on top of your CD maturity dates.
- You do not readily have access to your money. If you end up needing money during the CD term, if you go to withdraw funds you will likely lose interest earnings and possibly principal for the early withdraw.
What does a CD investment look like?
| Term | Deposit | Interest Rate | Earned Interest | Ending Investment Total |
|---|---|---|---|---|
| 1 year | $1,000.00 | 1.75% | $17.50 | $1,017.50 |
| 3 Year | $1,000.00 | 1.85% | $56.53 | $1,056.53 |
| 5 Year | $1,000.00 | 2.25% | $117.68 | $1,117.68 |
Final Thoughts
Remember whenever you invest money to first invest time by researching the best institutions and types of investments out there before putting your money away in a CD for a long period of time. Consider shorter CD terms when you are first getting started. You do not want to need cash down the road and have it all locked in a CD. Be sure to begin to diversify once you have more to invest, or having multiple CDs that mature at different times. Happy investing!
