What Is a CD?
Certificate of deposits (CDs), also known as ‘cash equivalents.’ CDs are types of savings products that banks & credit unions offer, allowing you to deposit an amount of money for a certain amount of time & earn interest on your investment. You agree to leave your funds invested for a set length of time when you open a CD—whether it’s 6 months or sometimes even 5+ years—and in exchange, the bank typically pays a higher rate of return (interest) than standard savings accounts.
CDs may be appealing for investors who are seeking a low-risk option to grow their savings steadily. Since the rate of return on your investment is guaranteed from the very day you invest, you will know what interest rate you will receive at the end of the 6-month, 1-, or 5-year terms. Many savers use CDs to achieve their short-term financial goals, build an emergency fund, or fund a long-term plan without concern about fluctuations in the stock markets.
How CD Interest Works
When you put money in a CD, you will earn interest on the balance of your original deposit plus interest that has already been earned. This is called compound interest. Many banks compound interest daily; others do it monthly, quarterly, or yearly. Generally speaking, the more frequently you compound your interest, the larger your balance will grow over time.
For example, if you placed $5,000 in a CD with a specific rate of return, the principal would grow as you earned more and more interest.
Once your CD reaches maturity (the date it matures), you will get back the original amount and interest that has accumulated while in the account. If you use a CD calculator, you can find out how much interest you can expect to earn based on your investment length.
Benefits of CDs
Secure Savings with Certificates of Deposit
Most people consider Certificates of Deposit (CDs) as their safest form of savings. Most CDs provided through banks are FDIC insured, and CDs provided through credit unions are typically NCUA insured, so your investment is protected by both organizations up to certain amounts.
With fixedness and predictability, you can plan.
Unlike many investments that experience fluctuating values, CDs have a fixed interest rate for the duration of the CD, so you can easily track your savings because you will know exactly how much interest you will earn upon maturity.
Higher Returns than Traditional Savings Accounts
Higher returns on many CDs when compared to regular savings accounts mean that your funds earn more interest over time and you will have more money to spend in the future.
Using CDs to Accomplish Financial Goals
You can utilize CDs as a way to save towards specific future needs like vacations, educational expenses, an emergency fund, or a large purchase.
CD vs Savings Account
Both methods allow you to grow your money, but they work very differently. A standard savings/chequing account gives you immediate access to your funds by providing room for both deposits and withdrawals any time you like; however, in general, the rates you earn from these types of accounts tend to be much lower than what you would earn from a certificate of deposit (CD).
When the money remains untouched during the course of the term of the money, banks are able to compensate savers with higher returns for having kept their funds there for that amount of time. CDs are really good for those people who do not have immediate need for the funds and want to see consistent earnings on their money throughout that time frame. Daily access and being able to ultimately get your money for an emergency are the key features of a regular savings/checking account versus stable long-term savings with a CD.
Frequently Asked Questions (FAQs)
Yes, CDs are generally considered very safe. Most bank-issued CDs are insured by the FDIC, while many credit union CDs are protected by the NCUA.
Yes, but most banks charge an early withdrawal penalty if you take money out before the CD reaches maturity.
APY stands for Annual Percentage Yield. It shows how much interest you can earn in one year, including compound interest.
CD terms can range from a few months to several years. The best option depends on your savings goals and financial plans.
Most CDs come with fixed interest rates, meaning the rate stays the same throughout the entire term.