Why Open a CD?

Reasons it may be right for you—and alternatives if it's not

People in an office

Jokic / Getty Images

When you open a certificate of deposit (CD), you agree to keep your money untouched until it reaches its maturity date. In exchange for this commitment, the issuing bank, credit union, or broker pays a higher interest rate than what you’d get with a traditional savings account.

Even with a better interest rate, a CD may not always be the right vehicle to save your money. CDs are less liquid than standard savings accounts, so you can’t add or withdraw money during the term. You’ll also pay an early withdrawal penalty if you cash in your CD before maturity, usually by forfeiting the interest earned.

Learn more about how certificates of deposit work, when it makes sense to open one, and some alternatives to consider if you’re searching for some savings options.

Key Takeaways

  • A certificate of deposit is a type of savings account that pays a specific interest rate over a predetermined period.
  • CDs lock your money for a period of six months to five years or more, and an early withdrawal penalty applies if you cash in your funds before maturity.
  • CDs are subject to the prevailing interest-rate environment and may be lower when interest rates are down and higher when interest rates rise.
  • Other investment and saving vehicles may provide more returns and liquidity than CDs.

How Does a Certificate of Deposit Work?

A certificate of deposit is a type of savings account that lets you lock a fixed amount of money for a set period, typically from six months to five years. In exchange, the bank issuing the CD will pay you interest until maturity. When your CD reaches maturity, you can cash in your principal plus the interest earned, or roll over the balance to a new certificate of deposit.

You must inform your bank what you want to do with the CD before it matures; otherwise, it will automatically roll over to a new CD.

CDs often pay higher interest rates than traditional savings or money market accounts with the same issuing bank, with higher rates applying to longer terms. Bank-issued CDs are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). This insurance covers all accounts you hold at the same bank and not each individual account or CD at the bank.

Traditionally, CDs have paid a fixed interest rate over their term. Today, you may also find variable-rate CDs, also known as market-rate CDs. These accounts adjust the interest rate as market rates rise and fall. If prevailing interest rates are low, a variable CD lets you lock in higher interest rates when rates increase.

Tying up your money for a higher interest rate is not always convenient. You can’t deposit or withdraw money from your CD during its term. You must deposit the full amount when you buy the CD. You’ll also pay an early withdrawal penalty if you cash in your CD before maturity.

The early withdrawal penalty for cashing in your CD is usually a percentage of the interest you’ve earned.

Brokerage firms, investment professionals, and independent salespeople may offer CDs. These entities and individuals are referred to as deposit brokers. Brokered CDs may carry longer holding periods and promise higher interest rates. Always conduct a thorough background check on the issuer or deposit broker since they may not be licensed, certified, or approved by any state or federal agency.

Besides regular CDs that have a term limit of five years, there are also long-term, high-yield CDs that offer a higher rate for terms as long as 10 or 20 years. Take care with such CDs since the issuing bank has a right to terminate the account and pay back your principal and interest earned at any time.

4 Reasons To Open a CD

A certificate of deposit is considered a conservative investment because it’s FDIC insured and carries a relatively short term. Deciding whether to invest in a CD depends on your circumstances and market conditions. First, you’ll want to have some savings in an easily accessible account since you’re tying up money for a specific period. Different interest-rate environments will also make or break your decision to open a CD. Here are some reasons why investing in a CD might make sense.

You Are Saving for Large Purchases or Investments

Opening a CD is an ideal way to save up for a large purchase or investment. In return for keeping your cash for a set period, your issuing bank will typically pay more interest than you’d get from a normal savings account. You’re assured that your money will continue to grow and there’s a guaranteed minimum return upon maturity.

CDs also carry a penalty for early withdrawals, so you’re less tempted to pull funds from your account prematurely. Although the penalty isn’t particularly harsh, withdrawing early could reduce your return or force you to close your CD before it generates its full value.

You Want a Low-Risk Investment

A CD guarantees a specific minimum return on your money. Issuing banks will offer a higher annual percentage yield (APY) on your money since they can put it in longer-term investments.

CDs issued by FDIC-member banks are insured by the Federal Deposit Insurance Corporation up to $250,000, so you’re protected against losses should the bank fail.

To enjoy the maximum protection by the federal insurance, ensure your combined deposit accounts—CDs, savings, checking, and money market accounts—are within federal limits.

You Don’t Need Immediate Access to Your Money

A CD is a type of “time deposit.” It holds a specific amount of money for a predetermined period. You’ll pay an early withdrawal penalty if you need to access your funds before the maturity date, which typically eats into the interest you’ve earned.

Opening a CD makes sense if you won’t need the money before the term lapses. Be sure to have an emergency fund tucked away in an easily accessible savings account should a situation arise where you’ll need cash on hand.

CD Rates Are Good

Interest rates on CDs are usually more competitive than rates on normal savings accounts. You can also lock in a fixed rate for the CD’s term, while the interest rates for most savings accounts vary depending on the prevailing market conditions. Instead of constantly scrounging for the best rates, you can deposit funds in a CD offering a competitive annual percentage yield (APY) and leave it for years.

CDs are subject to prevailing market conditions. CD rates may be lower when interest rates are down and higher when interest rates rise.

Alternatives to CDs

When CDs are not great options, consider investment vehicles that are low risk and guarantee a return on your money. Some CD alternatives to consider include:

  • Bonds: Bonds are debt securities that pay fixed interest for a certain period. In exchange, you lend money to a corporation or government that makes regular payments toward the debt. Types of bonds include U.S. Treasury bonds, corporate bonds, and municipal bonds.
  • Dividend stocks: Many large companies distribute a portion of their profits to shareholders in the form of dividends, which are usually paid quarterly or annually. Dividend yields can be higher than the returns on a CD. This investment could also wipe out part of your principal if there’s a decline in the stock value.
  • High-yield savings accounts: A high-yield savings account also pays a higher interest rate than what a normal savings account offers. These accounts are often available through online banks that have lower overhead costs.
  • Money market accounts: Money market accounts guarantee the security of a CD while returning yields higher than a traditional savings account. Money market accounts may require higher opening balances and limited withdrawal privileges. Similar to CDs, high-yield savings accounts have FDIC protection.

You may also reap maximum benefits with minimal risks by using the CD laddering strategy. By creating a CD ladder, you spread funds across multiple CDs with different maturity dates. You’ll have some funds available to use or roll over at different intervals.

Are CDs Worth It?

CD investments are an ideal option if you’re looking for a safe haven to store your savings and earn a guaranteed return over a fixed term. Note that CDs are less-liquid savings accounts, so you can’t withdraw or add to your initial deposit before maturity. In this case, you may explore other alternatives that offer a lower investment risk while guaranteeing a return over a specific period.

Frequently Asked Questions (FAQs)

How do I open a CD account?

To open a CD, you must create a new account with an issuing bank or credit union to open a CD. Check whether the institution is insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Read your issuer's disclosure statement carefully before funding your CD with the minimum opening deposit.

How much money do I need to open a CD?

The amount of money you need to open a CD depends on the issuing bank and the type of CD. Some CDs carry a low minimum opening deposit, while others have higher minimum opening balance requirements. Jumbo CDs, for example, usually require a minimum balance of $100,000.

Where can I get the best CD rates?

Comparison-shopping product offerings from multiple issues will help you secure the best CD rates. Online banks and credit unions may provide higher interest rates than big banks. Large account balances may also qualify you for higher rates. You may also lock in higher rates with longer-term CDs whose maturity extends up to 10 or 20 years.

Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!

Article Sources

  1. FINRA. “Certificates of Deposit (CDs).”

  2. Office of the Comptroller of the Currency. “I Cashed My Certificate of Deposit (CD) Before It Matured, and the Bank Charged Me an Early Withdrawal Penalty.”

  3. Comerica. “3 Ways a CD Helps You Prepare for Big Purchases.”

  4. New York State Attorney General. “Your Investment Options.”

  5. Cooperativa Latino Credit Union. "Deposit Accounts."