What is a Certificate of Deposit (CD)?

Woman putting coins in a piggy bank


You may be wondering if a certificate of deposits (CD) is a good investment or savings vehicle to help you reach your financial goals.

The answer is, it really depends. Before putting money into a CD, you should consider the state of the economy and CD interest rates, as well as when you think you'll need to access the funds.

In addition to higher interest rates than a traditional savings account, CDs also have a fixed term, which means that you can't make a withdrawal until the term is up or you'll pay a hefty fee. Read on for more facts about CDs and to learn if they are right for you.

What Is a CD?

A CD is a type of savings account that has a fixed rate of return and a fixed maturity date. The interest rate is usually higher than a normal savings account or a money market account, which means that a CD can be an excellent way to save for a financial goal a set amount of years in the future, such as sending your child off to college.

CDs are considered to be one of the safest investments on the market since risk is low and you are guaranteed the annual percentage yield (APY) that was available when you opened the CD.

When Should I Use a CD?

You may consider setting up a CD if you know that you will be using the money in a specific period of time and will not need to access it immediately. They are great low-risk savings tools to help you reach your financial goals, as long as you don't need access to the funds.

Avoid dipping into your CD by having a solid emergency fund in place, though you may consider using a CD ladder as a savings tool for your emergency fund.

Generally speaking, CDs are ideal for short to mid-length financial goals, since their rate of return isn't very high. If you are looking at a goal for more than five years in the future, consider investing in a mutual fund. While a mutual fund is riskier, you will get a substantially higher return.

The Risks

One of the biggest risks of a CD is that you will not earn interest at the rate of inflation. Additionally, if you do need to access the money before the CD term is up, you will pay penalties and early withdrawal fees.

When choosing a CD, you are choosing a product that will keep your money safe, but not necessarily helps it to grow, since the rate of return is so low. However, most CDs are FDIC-insured for up to $250,000, so if you are risk-averse, you may decide a CD is the best choice for you and your money.

Features to Look for in a CD

CDs have different options when it comes to paying interest on the account. Many CDs will deposit the interest into one of your accounts monthly or quarterly. Other CDs will add the interest back into the CD or pay the interest at the end of the term.

Additionally, some CDs will automatically roll over into a new CD at the current market rate. If this is the case, you need to mark the date on your calendar so that you can withdraw it and put it into a better investment option. When you open a CD, be sure to educate yourself on the different interest options available.

Alternatives to a CD

If you are using CDs because you are leery of investing in the market, you may want to consider choosing mutual funds instead, since they spread the risks over a wide variety of stocks. This will reduce your risk, but give you a higher rate of return.

A good financial adviser can help you find the best options that will reflect your risk tolerance when investing. You may want to look at other options like annuities or bonds to grow your money. However, a CD may be a good option if you are looking for a better place to put your money because of low savings account interest rates.

Updated by Rachel Morgan Cautero.