About CDs |
A CD typically bears a specified fixed interest rate, a maturity date, and can be issued in any denomination. Variable rate CDs, including those with step-up or step-down features, are available but are far less common. CDs are generally issued by commercial banks and credit unions with terms of one month to five years, and cannot be changed once the CD is originated.
Most financial institutions provide for automatic renewals or rollovers upon expiration of the original maturity period. Video: What Is a Certificate of Deposit? Purchasing a CD is a relatively simple process and can be done in person, through the mail, or online. The “certificate” is usually a confirmation letter which documents the amount, term, interest rate, and maturity date. Unlike a savings account, a CD is issued for a fixed amount that will not change during the term period. In addition, the CD is a time deposit that restricts holders from withdrawing funds on demand. Safety and risk assessment
Advantages and disadvantagesThe primary advantage of the CD is that the investor can calculate his expected earnings at the beginning of the investment. It offers a simple solution for those who desire only to maintain their capital without assuming any risk, such as seniors on fixed incomes. The major disadvantage is that although choosing a longer maturity period will normally yield a higher interest rate, the investor loses access to his funds and forgoes alternative uses of his capital. Withdrawing funds before the maturity date will subject you to early withdrawal penalties. It’s important to note that CD interest rates closely track the rate of inflation. In fact, if the rates are the same, you actually lose money because the interest earned is fully taxable. Investors should realize that although they are a safe haven for your money especially in troubled times, they are not a good investment over the long run when compared to stocks and mutual funds. On a short-term basis, they are a good alternative to not having your money invested at all. CD terms and ratesThe key choices you make when opening a CD are the total amount invested, term, and corresponding interest rate. The reward for a longer term is typically a higher interest rate. This is because a longer term gives the bank greater flexibility in its ability to loan your money to other customers, or pursue other investments to create even greater returns. When the CD is opened, you will typically be offered the option of having the interest mailed as a check or transferred into a checking or savings account. This reduces the total yield because there is no compounding of interest. Also, the issuer may retain the power to call the CD or close it before the end of the term. Video: How Does a Certificate of Deposit Work? During periods of high interest rates such as the late 1970s and early 1980s, CDs can enjoy a relatively high return, but usually at the expense of correspondingly high inflation. The reality is that CD rates vary widely but track very closely with the rate of inflation, which has been fairly low for the past several years. During periods of low inflation, the Federal Reserve has typically lowered the fed funds rate which has resulted in lower interest rates on CD accounts. The current fed funds rate is only 0.25% as a result of several cuts to attempt to stave off a worsening recession. For a one-year CD, interest rates are currently in the range of 2-3%. Since rates fluctuate, the rate you will receive will depend on the date you make the purchase and the length of the maturity period. Below is a list of financial institutions that are providing some of the highest annual percentage yields currently available: GMAC Bank UFBDirect.com Corus Bank Nexity Bank Ascencia, a division of PBI Bank UmbrellaBank.com Intervest National Bank AIG Bank
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A CD is a very low-risk investment, and for some is an alternative to a money-market account. It is also often a place for investors to safely park cash when they are in between investments in other financial instruments like stocks, bonds, and mutual funds. The safety of your investment is guaranteed by the