What is a Certificate of Deposit?
Certificates of deposit are sold by banks. They are more widely known as CDs. Typically, CDs are low risk but generally low returns. CDs are great for keeping cash in a safe place where you won’t need it for months or years. CDs carry a commitment. You cannot withdraw the funs for a predetermined amount of time. The duration varies quite a bit, anywhere from short term one month CDs up to 5 years is common. Usually the longer the time frame required, the higher the interest is. Unfortunately, if early withdraw is required, a penalty will likely be assessed. All gains from CD accounts (unless in a IRA) are taxable.
CDs are very safe investments, about as safe as they get, in fact. CDs are FDIC insured providing your bank is FDIC insured. The predetermined rate the bank gives you is guaranteed. If rates slide while you are in the CD, you are locked in at the original rate. On the contrary, the same is true if rates rise.
Some common CD types are:
Traditional CD: A predetermined interest rate is paid over the predetermined term, or length of time. When the term is up, you can remove all funds plus interest or renew the CD at most current rate.
Bump Up CD: Basically, these are the same as traditional CDs. The only difference is you are allowed to contribute additional funds usually once, in addition to the opening amount.
Liquid CD: This type of CD account allows you to withdraw funds before the maturity date. Since you have more freedom, it comes with a cost, a lower interest rate. The rate will still be higher than a typical money market account though.
In addition, most of the above accounts are available at your local branch or online. I have found that online accounts usually have much better rates than local banks.
CDs are great investments. For people nearing retirement, they are ideal due to their security. CDs are guaranteed and will never lose money. CDs can also be used for your emergency funds as well. Simply pick a shorter term. If needed, you can withdraw funds early, but the penalty will be assessed. The penalty is usually a few months interest. However, since this is your emergency fund and it should only be used for true emergencies, hopefully the interest has paid you far more than you will lose for early withdraw.
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