Certificates of deposit, or CDs, are savings investments that typically have higher interest rates than traditional savings accounts and can help savers reach their financial goals faster. However, CDs differ from traditional checking and savings accounts, so it is crucial to understand precisely how they work before investing in one.
In this article on certificates of deposits, you will learn what you need to know about these investment products to make the best financial decision.
Certificate of deposit: What is it?
The Certificate of Deposit, or CD, is a type of investment account in which the account holder invests money for a fixed period of time before receiving a higher interest rate.
The longer you invest your money, the better your return will be. Some people choose to invest their entire life savings into one long-term CD, while others may put just a small portion of their savings into one.
In general, using all your funds on a long-term CD is only recommended if you are sure you will need all of the money at once.
An investment in a CD, however, might be the perfect solution if you have a lot of extra cash that you would like to make some decent returns on without having to worry about withdrawals.
Just keep in mind that when you open this kind of account early, some fees will likely be charged. Make sure these penalties will only eat away a little of your profits before committing yourself.
Certificate of deposit: Points to be noted
- Certificates of deposit (CDs) are low-risk investments that pay interest on the money you deposit.
- Banks and credit unions issue CDs.
- If you need cash before your CD matures, you will likely have to pay an early withdrawal penalty. To avoid this charge, consider using other types of investments like stocks or bonds until your CD reaches maturity.
- The interest rate for certificates of deposits can vary based on when they were issued. Make sure you understand what type of certificate you’re buying so that it suits your financial goals.
Certificate of deposit: Why do you need to open a CD?
The interest rate on CDs is fixed for the duration of the CD, typically ranging from three months to five years. This means you know exactly how much interest you will earn each month and your annualised yield.
CDs can be an excellent way to save or invest money, but they have certain limitations. To open and maintain your CD, you will need a minimum initial deposit and stay in the same financial institution for the term.
Certificate of deposit: Difference between CD and FD
A certificate of deposit (CD) and a fixed deposit are both ways to invest your money. The main difference between a CD and FD is that a CD locks you in for a predetermined period of time, whereas an FD allows you to come and go at any time.
For example, if you put Rs 500 into an FD for three months, at the end of those three months, you can either withdraw the Rs 500 plus any interest that may have accrued or re-invest it for another three months.
With a CD, once you lock in the amount and duration of your investment, you cannot access the funds until after that term has elapsed. In other words, CDs are like long-term savings accounts, while FDs are more like short-term investments.
Certificate of deposit: Pros of investing in a certificate of deposit
CDs have some unique characteristics that make them attractive:
- They offer predictable returns because there is no risk that rates will go down before your CD matures.
- CDs typically have higher interest rates than other investments. Interest compounds daily so that the interest earned in a CD builds on itself over time. When the CD matures, at its end date, all accumulated interest is yours to keep (unless otherwise noted).
- Most CDs also allow you to add more funds without paying any penalties or fees. That way, if market conditions change and you need cash back out of your CD, you are not penalised for doing so as long as it’s within six months of opening the account.
Be aware, however, that most banks only let you do this once during the life of the CD. In the event that you withdraw money after this point, you will be charged a penalty for early withdrawals.
Certificate of deposit: Cons of investing in a CD
There are cons when investing in a certificate of deposit:
- This type of investment is that banks usually only offer them as short-term deals with terms ranging anywhere from 30 days up to 5 years.
- Your CD won’t grow if inflation goes up while you are saving up for retirement, with the goal not to touch any of it until then.
- You may be charged a penalty by some banks if you withdraw your money before the CD term expires. These early withdrawal penalties can range from 3-6 months’ worth of interest.
- It has lower returns than other investments, such as stocks and bonds.
Certificate of deposit: How much profit does a CD make?
The interest rates on CDs depend on the length of time they are left untouched. The longer the period, the higher the interest rate. If you invest Rs 8,26,805 in a CD for two years at 1% APR, you will earn an additional Rs 8268 in interest over two years or Rs 82680 in total earnings.
Certificate of deposit: How to open a certificate of deposit?
Banks and credit unions offer certificates of deposit in the form of savings accounts.
If you open one, you’ll have to make an initial deposit with your bank or credit union, and then you’ll be able to lock that rate in for a specified period of time.
If the CD has an annual percentage yield (APY) that is higher than what is being offered on other certificates at the same bank, this may be worth exploring before investing elsewhere.
FAQs
When does a CD pay interest?
Interest on a CD is generally compounded daily or monthly, depending on the account. Some CDs allow interest to be transferred to other accounts, like savings accounts or money markets.
Can anyone issue a certificate of deposit?
A Scheduled Commercial Bank, a Regional Rural Bank, or a Small Finance Bank can issue a CD.
Is there a risk associated with certificates of deposit?
When you withdraw your money early from a certificate of deposit, you may need to pay the penalty. Make sure you do not need this money during that time since it can be a drain on your earnings. It is also critical to consider that rates may change during the term of your loan.
Upon maturing, what happens to a CD?
The money you put in a certificate of deposit (CD) is returned to you when it matures without paying any early withdrawal penalties.
Is there a limit to how long you can leave money on a CD?
The interest rate on CDs typically increases with the term's length, ranging from three months to five years.