While most people with even a passing familiarity with the most popular savings vehicles have likely heard of a Certificate of Deposit (CD), the truth is that its flexibility, reach and potential impact as a financial tool may just surprise you.
Is a CD a good fit for your own unique monetary goals and resources? What is a certificate of deposit?
The following primer can help you find out…
How do CDs work?
Typically offering higher interest than savings accounts, CDs are a potentially great way to save whether you’re saving for short or long term goals. There is, however, a caveat: When opening a CD, a customer agrees to a term length — typically anywhere from 30 days to five years or more — and a required minimum opening balance that is usually higher than other deposit accounts. In most cases, the longer the term, the higher the interest rate. CDs typically have no fees unless funds are withdrawn before the maturity date.
How do I know if a CD is right for me?
If you have unused funds earmarked toward a specific financial goal — such as buying a house, financing a loved one’s education or saving for retirement — then the possibility of opening a CD should be explored. Remember, however, when selecting the term to be sure your money is available when you need it to avoid penalty fees for early withdrawals. It is also wise to save some of your unused money in a more liquid deposit account such as a money market or checking account to tap if the unexpected occurs.
Certificate of Deposit advantages and disadvantages
Deciding whether or not to open a CD often boils down to weighing the advantages and disadvantages.
- Higher interest rates: Depending on the type of account, a CD will almost always yield a higher interest rate than other traditional savings accounts.
- Safety: FDIC insurance up to $250,000 per depositor applies like other deposit accounts, so you know your money is safe.
- Predictable returns: In contrast with other investment vehicles, CDs offer predictable, guaranteed returns on the funds you put in. You set aside a specific amount at a fixed rate for a specific amount of time, so you don’t have to worry about performance. For example, if you place $10,000 in a CD at 2.25% for 1 year, with interest compounded daily, you’ll know exactly how much you’ll have at the end of that year — $10,228, representing an annual percentage yield earned of 2.28%. Visit the First Republic CD calculator to see potential earnings at different interest rates and term lengths.
- Early withdrawal penalty: The money is locked for a set period and can only be withdrawn at maturity; otherwise, a significant early withdrawal penalty applies.
- Due diligence: If your CD is longer than 1 month, your bank will likely inform you when your CD term is about to expire. If you somehow miss the notifications, however, your account could automatically roll over into a new CD, making it harder or more costly to access your cash before your new term limit is up.
A Certificate of Deposit offers a lot of positives — but it’s important to understand all the details and conditions before signing on the dotted line. Only then can you truly determine whether a CD is the right vehicle to help you reach your future financial goals.