What is a CD?
A friend of mine recently asked me what a CD is, so I thought I would spell it out here as well. Other than a wonderful alternative to cassette tapes, a certificate of deposit (CD) is an agreement with someone (normally a bank) to give them X amount of dollars for Y amount of time.
That “someone” to whom you gave your money will, after Y days or years, give your money back to you with interest added in. Under normal market conditions you will generally receive a higher interest rate the longer you agree to give up your money.
Common CD terms are 3 month, 6 month, 12 month, 2 year, 3 year, and 5 year.
A few notes about CDs:
- CDs will almost always pay more than a savings or money market account, but as mentioned earlier the trade off is the lack of liquidity.
- A CD is often a good option if you know you will need that exact amount of money on a specific date in the future. (i.e. vacation)
- Normally deposits are not allowed once the CD has been opened.
- Early redemptions of CDs are allowed, but you will often times have to pay back all the interest you have earned and sometimes even a bit more.
- CDs purchased at a bank will most likely be [tag]FDIC insured[/tag].
- You can find the best rates on CDs at Bankrate.com
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Filed under Investing online for beginners by bob
Comments on What is a CD? »
Hello there,
Never heard about CD. But the concept is great. Will try it the day i’ll be earning.
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Thank you!!!
Nice write up. Right now with on-line savings and money market account interest rates being so high, not sure if CDs are the best place to put your money. While they may offer a slightly higher interest rate, as you said they are not liquid. You could put the same money in an ING Direct or HSBC. They offer 4.5% - 5% interest savings accounts, and the money is fully liquid. You can have the money in your hands within 3 days. Personally, I have both an ING Direct savings, and a CapitalOne Money Market account where I keep my emergency money. The CapitalOne Money Market account is 4.75% interest and has full check writing privileges. This way if I need my money now I can get it. No penalties, fees, etc.
When making the choice to use a CD, I think you really need to consider if you will need the money or not. Given the marginal difference in rate, if you even think you might need the money, just place it in a high interest savings account.
Thanks Bob, nice write-up.
@larry
Oh, I agree you with you completely. I probably should have mentioned that in the post. With savings rates as good as they are you are talking about gaining maybe a few bucks for a pretty huge trade off of liquidity. The market will change of course, but for now even some of my longer term money is in high-yield savings accounts rather than CDs.
Yes, the market will change. Just no one knows when. Historically though, the Fed has not raised rates after pausing like this. Of course, they have never paused this long either.
We do have some Historical CD Rates posted at our site.
Keep in mind that if the rates move down, savings and money-market accounts will go down much faster than a CD will.
If rates go up, most likely, the curve will invert again, because banks won’t want to pay a “high premium” for the longer-term funds. They would rather wait out the storm and hope for rates to go back down soon enough.