Certificates of Deposit (CDs)

Certificates of Deposit, or CDs (not to be confused with Compact Discs), are deposit accounts that have conditions. You agree to deposit your money into an account for a predetermined period of time. The length of this term can vary from three months to as long as ten years. In return for the use of your money and its loss of liquidity during the time that it’s deposited, you’ll earn a predetermined rate of return. CDs sold by banks are backed by Federal Deposit Insurance Corporation (FDIC) insurance for deposits up to $100,000 per financial institution; those which are sold by brokerage houses are not. Due to the agreed-upon loss of liquidity for the length of the CD’s term, if you choose to withdraw some or all of your money before that time (in other words, before the CD matures) you’ll have to pay a penalty of a number of months’ worth of interest. The size of the penalty is outlined in the terms of the CD agreement.

Bank-issued CDs are the most common by a wide margin, but you may also come across competitive broker-sold CDs. These CDs are usually from small banks that can’t afford widespread marketing programs, so they hire outside brokers as their sales force. If you buy a CD from broker, you’ll pay no commission; they receive their compensation by markup, which is the difference between what they paid for the CD and the price at which they sell it to you.

Virtually every bank sells CDs, most with a minimum deposit amount of $1,000. They’re very easy to open; simply find a bank that’s paying acceptable interest rates, fill out the forms that are given to you, and make your deposit. When the CD matures, you have a choice of either withdrawing your money and its earnings or rolling it over into a new CD. If you do neither, most banks will automatically roll the funds over for you into a CD of the same term length as the old one. Because of this, most banks will also notify you a few weeks before the CD comes due. Some, however, will not, so be sure to keep and stay abreast of your own investment records.

CD rates of return are as numerous and varied as the banks that issue them. They do, however, tend to increase as the amount of your deposit and the term length of the CD increases. When evaluating CD deals there are two numbers which you must be aware of: the rate and the yield. The rate, of course, is the amount of interest that the CD will pay. The yield, which is always the higher number, is also known as the APY (annual percentage yield). Note the word “annual”: you’ll have to leave your CD on deposit for one full year at the quoted interest rate in order to receive the stated yield. So, if you have a three- or six-month CD, you will only receive the stated yield if you roll it over enough times to last for one year.

The only way to find the best CD rates being offered is to search for them by shopping around. Don’t limit yourself to local banks; with the proliferation of the internet and online banking you can check and purchase offerings nationwide. You can also check with your broker to see what deals are available. A good broker will have already shopped the country for the best offerings, and you may be able to get a slightly better return as a result. In addition, working with a broker has the advantage of knowing that someone is monitoring your accounts when rollover time approaches.

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