Certificates of Deposit

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Certificates of Deposit

Certificates of deposit (CDs) are time deposits issued by banks and credit unions. (Credit unions refer to them as certificates.) They are sometimes referred to as small savings CDs.

CDs are short-term (usually one month to 60 months), and they pay interest at the end of the term (when the CDs mature), or at various times throughout prior to the end of the term, depending on the structure of the CD. They often pay a higher rate of interest than a savings account. CDs that take longer to mature tend to pay higher interest rates. The minimum initial investment varies from bank to bank and from CD to CD, but is usually $250 to $1,000.

How CDs work

When you deposit money into a CD, you must leave it there for a specified term for a stated interest rate (although some CDs have variable rates). Credit unions pay dividends rather than interest. When you will receive your original investment and interest depends on the CD. Some pay interest over the course of the term; others pay at maturity. With CDs, you know how much you will earn, and you know when the money will be available to you. CDs are appropriate for investors who need low-risk investments with fixed maturity.

You may be charged a penalty if you withdraw your money from a CD before maturity.

Most CDs carry insurance

CDs issued by banks, credit unions, and some savings and loan associations are insured by the FDIC, the NCUSIF, or other federal deposit insurers, for up to $250,000 (and $250,000 for retirement plan accounts) per depositor.

CDs sold by brokers

Brokerage firms also sell CDs called brokerage CDs. They look for brokerage CDs with competitive rates and offer them to their customers. You pay a fee for a brokerage CD bought from a broker. Interest on a brokerage CD is not FDIC insured and is not subject to a penalty for early withdrawal. However, the investor may suffer a loss if the brokerage CD is sold prior to maturity.

Special types of CDs

There are many variations on CDs. For example:

• Variable-rate CDs offer rates that change along with interest rates.
• Add-on CDs allow the investor to add to them after they have been opened.
• Discount CDs are sold to the investor for less than their face amount. Upon maturity, he or she receives the original face amount of the CD.
• Negotiable CDs come in $100,000 denominations and can be traded on the market like stock.

CDs are an effective vehicle for short-term investments when you need an assurance that your principal (if held to maturity) and interest won’t fluctuate.