What is a Certificate of Deposit (CD)? Secure Your Savings with a Guaranteed Return
One of the most important first steps toward financial stability is saving money. However, it can be difficult to determine where to put that money for development. With so many alternatives for investing, from high-yield savings accounts to stocks and bonds, it’s critical to strike a balance between risk and return.
Some financial products provide a dependable route to consistent growth for those who value stability and predictability above high-risk profits. One such choice is the certificate of deposit, which offers a means to safeguard your investments while ensuring a steady return. Knowing how it operates and why it could be advantageous will enable you to invest your money wisely.
In this article, we will learn how you can secure your savings with a guaranteed return using a certificate of deposit. But before that, we will understand what is a certificate of deposit.
What Is a Certificate of Deposit?
Banks and credit unions provide Certificates of Deposit (CDs) that are based on time periods. These are savings products that let you deposit money for a certain amount of time and earn guaranteed interest.
A certificate of deposit (CD) offers greater interest rates than a standard savings account in exchange for locking your money for a longer time. CDs may interest you if you’re searching for a low-risk, safe way to increase your savings. This is especially true if you don’t need the money right now.
However, despite the benefits, there is very low interest in certificates of deposit by Americans. According to a Motley Fool article, only 6.5% of Americans had a CD in 2022. That’s a really small percentage, considering the guaranteed income it offers, along with the chance to accumulate your wealth over a larger duration.
The assured return is CDs’ main selling point. You can be certain of the precise interest rate you will get on your investment at the conclusion of the term. Since the rates are set and invariant to the state of the market, they offer a dependable means of making financial plans.
How a CD Works
You commit to depositing a certain amount of money into a CD when you open it. This length of time can be anything from a few months to many years. The bank gives you interest on the money you deposit throughout this period. You can withdraw the principal—your initial deposit—as well as the interest you’ve accrued at the conclusion of the period.
The interest rate is one of the biggest distinctions between a certificate of deposit (CD) and a conventional savings account. Since you promise not to take money out of a CD during the period, they usually have higher interest rates. Due to this, the bank can provide you with a higher rate of return because they have a reliable source of funding.
However, if you want to withdraw your money early, you might have to pay a penalty. The penalty amount can vary from bank to bank and the duration of the certificate of deposit.
For instance, suppose your bank has an early withdrawal penalty of 3 months of interest rates for a two-year CD. In that case, if you withdraw the money after six months of investment, you will lose the interest for the first three months. This means that despite holding your money for six months, you will only receive interest for three months.
According to MyStages, CDs are protected by FDIC (Federal Deposit Insurance Corporation) or NCUA (National Credit Union Administration). This makes them a very safe investment method as even if the banks don’t pay you, FDIC or NCUA will pay you. Therefore, some people prefer investing in CDs over the stock market or other investment options that are volatile and high-risk.
Types of CDs
A variety of CD options are offered to accommodate varying financial circumstances and savings objectives. The most popular kind is the conventional CD, which allows you to deposit a flat amount and collect interest over a certain time. Nevertheless, depending on your objectives, there are alternative solutions that provide greater flexibility or larger returns.
With a “bump-up” CD, for instance, you can raise your interest rate if the bank provides a higher rate for the duration of the CD. Suppose you believe that interest rates will climb in the future. In that case, this kind of CD is beneficial since it allows you to profit from any rises without breaking the CD.
Conversely, a “liquid” CD gives you the freedom to take money out of the account before the term expires without incurring fees. Liquid CDs provide more access to your money in an emergency, even if their interest rates are often lower than those of standard CDs.
Additionally, “jumbo” CDs have a greater minimum deposit requirement—typically $100,000 or more. Jumbo CDs are designed to reward investors who can make greater upfront investments by typically offering higher interest rates. Other kinds, such as zero-coupon or step-up CDs, support particular financial plans. However, most people stay with the regular or bump-up alternatives because they meet their objectives.
Besides these, there are many other types, such as:
- High-yield CDs
- No-penalty CDs
- Add-on CDs
- Step-up CDs
- Brokered CDs
- Callable CDs
- IRA CDs
Factors That Affect CD Interest Rates
A CD’s interest rate is determined by a number of criteria, the duration being one of the most significant. In general, interest rates increase with term length. Since the bank has access to your money for longer, a 5-year CD will usually give a greater rate than a 1-year CD. If you’re prepared to keep your money locked up for a longer period, this trade-off could be beneficial.
The interest rate may also be impacted by the minimum deposit requirement. Some banks encourage customers who make greater upfront investments by offering higher rates on larger deposits. Even for the same period, you could discover that the rate on a $10,000 CD is greater than that on a $1,000 CD.
The policies of the Federal Reserve also affect the interest rates on CDs. The interest rates given on CDs may fluctuate with changes in the Federal Reserve’s lending policy. Even if CD returns aren’t as appealing in a low-interest rate environment, they are greater than those of standard savings accounts. On the other hand, CDs become a more alluring choice when interest rates increase since they often give more competitive yields.
For instance, the Federal Reserve has reduced rates by 0.5% in September 2024. This has led to a slight decrease in interest rates. Experts predict that there could be another 0.5% decrease by the end of this year and 1% decrease in 2025. This could take the guaranteed interest rates on CDs towards a small decline.
However, most banks are currently offering an interest rate of 5% or more. Therefore, around 44% of Americans opened a CD in 2023, but 41% still don’t have it. Most people who don’t have a CD are concerned that opening an account will be too complex and take too long.
Frequently Asked Questions
When a CD is opened, can I put extra money into it?
No, you usually cannot add to a CD once you open it and make your initial deposit until the conclusion of the term. You would have to open a new CD if you wanted to invest more money. It’s not customary for banking institutions to provide “add-on CDs,” which let you make extra deposits.
When the CD matures, what happens if I don’t take my money out?
Most banks will automatically roll over your CD into a new one with a similar term and current interest rate. There is, however, normally a grace period, usually seven or ten days. During this time, you can select a different CD product or withdraw the money without penalties.
Are CD interest profits subject to taxes?
It’s true that interest received on a certificate of deposit is taxed. Regardless of whether you take the money out or not, you must include this interest on your tax return. At the end of the year, the bank will usually issue you a 1099-INT document that summarizes the interest you earned.
Certificates of deposit offer certain returns and serve as a secure location to keep money set aside for future financial objectives. The secret is to pick a CD that fits your goals and carefully assess the duration and amount you feel comfortable locking up.
CDs stand out as a tried-and-true approach in the current financial landscape when people seek methods to increase their assets with less risk. They are still a good option for cautious individuals trying to safeguard their financial future since they offer the assurance of guaranteed interest.
