Certificate Of Deposit (CD) Basics


A Certificate of Deposit or a CD is one of the most favored and safest ways to make investments for a short or medium period of time. CDs are available at most of financial institutions, such as national/international banks and credit organizations.

Understanding Certificate Of Deposits

A CD can be simply understood as a financial instrument that offers a term-based assured return to the owner. By getting a CD, you basically agree to lend a certain amount of money (principal) to the issuing institution for a fixed period of time (term). This is why they are referred to as a type of Term Deposit.

The institution lends this money at higher rates or invests it to earn a profit. To offer you a financial incentive, the institution promises to pay a fixed (pre-determined) Rate of Interest (ROI). Although, CDs offering variable ROIs have been introduced, the traditional fixed-ROI CDs are the more popular choice. At the end of the mentioned time period, you get your Principal and the accrued interest.

Why CDs For Investment?

Economic cycles tend to vary, sometimes too frequently for your comfort and it becomes difficult to seek a secure mode of investment. Even the share markets tend to undergo the usually up-and-down cyclical phases. What’s more, saving deposits don’t have very appealing interest rates either. In such a scenario, a Certificate of Deposit comes across as the most secure way of investing your money and earning assured interest rates, which in the long-term are almost at par with other lucrative market-related investment schemes.

Compared to a typical savings deposit, a CD proves more profitable, though they can’t be operated with as much flexibility. Another feature that sets apart CDs is the pre-determined denomination in which they are issued. For example, CDs could be issued by a bank in pre-defined denominations of $500, $1,000 and $5000.

Purchasing CDs: You can purchase a CD for any period of time. The usual options extend from a few months to as long as five years. It is advised to purchase CDs for longer periods of time, as this allows an earning of a substantial amount of interest. However, purchasing CDs for more than five years is seldom recommended, because a bank’s own interest rates could undergo major fluctuations and you could find yourself stuck with a low-earning CD for a very long period. Again, various banks and financial organization offer varying rates of interest, so you have to do a personal research before making your decision.

Purchasing a CD from a bank is the norm but they can also be purchased through brokerages. Some banks may have minor stipulations, such as the presence of a banking account in your name, to issued a CD. However, the trend varies across the banking sector and some institutions are liberal enough to even entertain online applications and issue CDs.

Avoiding Penalties: You can incur a Penalty Fee if you request the institution to return you the money before the fixed time period expires. Therefore, it is always recommended not to withdraw your money prematurely from a CD, unless it is absolutely unavoidable. This is the only obvious drawback with CDs, i.e. your capital is no longer liquid and you are discouraged from making withdrawals.

Money Markets Vs Certificates Of Deposits – What To Choose?

It’s always difficult make a decision when it comes to investing your hard earned money. If you are made of stronger stuff, you can dabble in the stock market. Otherwise, you can look at steady and reasonably reliable options like money markets or certificate of deposits. Before we compare the two, it is important to understand the investment options.

Certificate Of Deposit

A Certificate of Deposit (CD) is a term based deposit or a promissory note issued by bank for a fixed interest rate, insured by the Federal Deposit Insurance Corporate (FDIC). An investor can purchase a CD for any denomination and earn the principal plus interest after term maturity. The investor also has the option to withdraw money from the CD before maturity if required, at the cost of some penalty. The main advantage of CD is that it offers higher rates than savings account and Treasury Bills.

Money Markets

Money Markets are deposit accounts that offer a relatively higher rate of interest as compared to a savings account. Money Market accounts can be opened at any financial institution. The difference between a CD and money market account is that the latter functions as a checking account. As an investor, your money is not tied up and you can withdraw your money as needed without incurring any penalty. In some cases, you may be required to give a short notice.

Some restrictions that differentiate the operation of money markets from checking accounts are the requirement of high minimum balance and a limit on number of monthly transactions. If you violate any of these restrictions, you will be charged very high service fees. Like CDs, Money Markets are also insured by FDIC and are considered a relatively low risk investment. They offer slightly rates slightly lower than the CDs but still higher than the savings account. Money Market account rates are determined by the amount deposited, higher the amount of investment, higher the rate. The interest rates are not determined by duration of investment.

Choosing Between The Two

Money Market for short term and higher liquidity: Clearly, money market is a better option for short term investment as it offers all the features of a CD as well as acts as a savings account. If you think you can work with the restrictions provided by banks/financial institution around the money market account, then this is recommended as a form of investment. Another advantage of investing in money markets is that if the market is doing well or the interest rates improve, you can withdraw this money and invest in better schemes like stocks, mutual funds etc. As interest rates are determined by the amount deposited, big investors gain more out of money markets.

CDs for long term and lower liquidity: If you can have surplus money that will not be required for a long duration of time, than CDs are good as they offer a higher rate of interest than money markets.

Investing In Certificate Of Deposits

Investing in a Certificate of Deposit does appear like a profitable proposition and there is no arguing over the financial security that it offers. However, before you purchase a CD, there are certain considerations that you need to evaluate and some questions that need to be answered. Only then can you be sure about your decision to invest in a CD.

Judge Your Compatibility With CDs

Not every individual is suited for investing in Certificate of Deposits (CDs). The reason is simple — every depositor has a different mindset regarding his/her investments. Only those investors who have the patience and the financial stability to purchase a CD and then leave it untouched until its maturity are suited for such investments. Individuals who are habitual in conducting frequent transactions from their investments or those looking for quick returns aren’t suited for CD type of investments.

CDs issued around the world incur penalties if money is withdrawn from them before the maturity period and it doesn’t make sense to invest money and then lose on profits by paying regularly paying penalties.

What Are Your Financial Goals?

Investors who seem fascinated by the double-digit interest rates that offered by market-based investment instruments should refrain from purchasing CDs. The lure of stock market lies in quick and sometimes extremely high profits. Both these features are absent in CDs. Instead, investing in Certificates offer security and long-term stability and not the dynamism that is seen among market–centric financial portfolios. However, none of the market-based investments, like annuities or mutual funds can guarantee risk-free returns like a CD because their profits are linked with the volatility of the stock markets.

Conclusion: you should consider investing in CDs only if you value the worth of secure, long-term and medium-yielding investments.

rocurement Of CDs: Bank Or Brokers?

One very obvious fact is that CDs issued by banks are perhaps the safest ones when it comes to investing your money. CDs that are issued by a bank are a form of bank deposit and hence they are insured by the FDIC — Federal Deposit Insurance Corporation. This one single factor makes bank CDs much safer than those purchased through brokerages. However, over the last decade some brokerage firms too have gained a reputation of being dependable. Still, you need to double-check upon certain things when investing in CDs purchases through a broker:

  • Brokered CDs are usually sold through commission-based intermediaries called Deposit Brokers who don’t need to have any particular licenses or registrations with federal agencies. Hence, you need to verify the authenticity of the broker. The best ones are those who are affiliated with some reputed investment firm.
  • In traditional CDs, issued by banks, the issuing authority lies solely with the bank itself. However, brokered CDs may have an assortment of some small investors, each owning a percentage of the total CDs issued. Your broker should tell you whether these investors are capable of paying back your principal amount in case you want to redeem your CD before time.

Ownership Of CDs

You can invest in CDs through either of the following modes of ownership:

  • Individual name or Single ownership — owned by one person
  • Joint ownership — this is in two forms: with survivorship or without survivorship

In joint ownership of a CD between with survivorship (usually among two holders), the death of one holder means that the entire CD is transferred in the name of the other owner. In cases of joint ownership without survivorship (usually with more than two holders), such privileges are withdrawn and there is no automatic division of the invested funds among the multiple holders in case any one passes away.