What is a certificate of deposit? A certificate of deposit (CD) is a document attesting to an agreement between an investor and a financial institution where the former invests a sum of money with the latter for a pre-determined period (referred to as the duration or the term) for which he or she will receive a higher rate of interest than those offered by a conventional savings or checking account.
What Is A Certificate of Deposit?
What is a certificate of deposit? They are one of the safest investments an individual may make as they are guaranteed by the Federal Deposit Insurance Corporation (FDIC) for amounts of up to $250,000 for every bank or credit union. For joint accounts, this doubles to $500,000.
While safe, CDs are also generally one the relatively lower-paying investments available to retirees.
What is a certificate of deposit? Regardless of the term, the investor may withdraw from the deposit before the end of the maturity period should the need arise, but this will incur a financial penalty. The penalty is dependent on the term but generally in the range of the interest that would be paid out in three to six months. For very short term CDs, like those of up to a month, the interest may be cancelled altogether. Because of this caveat, these accounts are called term deposit or time deposit accounts.
What is a certificate of deposit? The term may normally be as short as three months and as long as five years. Common terms of duration are three, six and nine months, and one, two, three and five years. Certain commercial banks offer Certificates of Deposit for periods as short as a week, but these are usually for very large amounts and not offered to most regular investors.
There are two main categories of term deposits in terms of value; those of less than $100,000 are called Small CDs and those exceeding that amount are called Large or Jumbo CDs.
The interest rates offered varies between institutions and fluctuate regularly, even as frequently as on a weekly basis. The two main factors that determine the interest rate paid are the term of the deposit and the value of the investment. Overall, they are closely related to the prevailing rate of inflation.
What is a certificate of deposit? One thing to note when choosing which CD account to invest in is the frequency at which interest is paid. If it pays interest annually, then the effective interest earned is the same as the advertised interest rate. However, if the interest is calculated, for example, on a three-month basis, the interest is added to the invested amount at the first payment, and all subsequent interest is calculated at the steadily-increasing value of the account. The latter system might seem trivially better at first but the differences become increasingly significant, particularly on CDs of longer terms.
Whereas CDs may be loosely defined as having fixed rates of interest once the term and amount are fixed, most banks offer the option of variable interest on large CDs and even some small ones.
What is a certificate of deposit? Here are some examples of typical CDs:
- Basic CD – Money is invested in the CD for a fixed period and the interest rate offered is fixed. Early withdrawal incurs a monetary penalty.
- Upgradeable CD – Some financial institutions offer their customers the opportunity to adopt a higher rate of interest for their CD account if the rates offered for the invested amount rise. This upgrade is typically only offered only once in the life of the CD.
- Liquid CD – At the expense of slightly lower rate of interest, investors have the opportunity to select this variation on the theme that affords them the privilege of withdrawing a part of the invested total without incurring a penalty.
- Callable CD – These earn a higher rate of interest than the basic CD but give the financial the option of canceling the CD should interest rates fall below a pre-determined level. Of course, the investor is still receives all his investment and the interest earned up till that point.
- Brokered CD – This option also rewards investors with an interest rate higher than that of basic CDs, but is only available through the purchase of an account with a brokerage firm.
A Certificate of Deposit can be an attractive option for retirees who have excess cash to invest but want to eschew the risk associated with alternatives that may offer more significant returns. Certificates of Deposit are generally considered liquid assets and are used for short-term durations. CDs are insured by the FDIC for the timely payment of interest, and if held to maturity, provide a guaranteed return of principal and interest. Annuities are long-term accumulation vehicles designed for retirement and have limitations; fixed annuity principal and interest rate guarantees are subject to the claims-paying ability of the issuing insurance company.
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The above information is not intended to substitute specific individualized tax, investment or legal planning advice. Where you need specific advice, please consider consulting with a professionally qualified and certified investment manager, financial planner, CPA or tax advisor.