Term Deposit

Loading the player...

What is a 'Term Deposit'

A term deposit is a deposit held at a financial institution that has a fixed term. These are generally short-term with maturities ranging anywhere from a month to a few years. When a term deposit is purchased, the lender (the customer) understands that the money can only be withdrawn after the term has ended or by giving a predetermined number of days notice. These types of financial products are sold by banks, thrift institutions and credit unions.

BREAKING DOWN 'Term Deposit'

Also known as certificates of deposit (CDs), time deposits and "bonds" in England, term deposits are an extremely safe investment and are therefore very appealing to conservative, low-risk investors. Term deposits sold by banks are insured by the Federal Deposit Insurance Corporation and the National Credit Union Administration for credit unions. Term deposits, because they allow banks to hold onto a deposit for a specific amount of time, allow banks to invest in higher gain financial products.

In return, financial institutions are more likely to pay higher interest rates to the lender. Most institutions will offer fixed rates, but it's not unheard of to have a CD with variable rates - one example was in the early 2000's when banks offered CD's that could have their interest rates bumped-up only once, and not lowered. Generally, interest rates should be proportional to the time and amount that the principle is lent to the credit union or bank. A 'jumbo-CD' for instance, (usually over $100,000) will receive much more in interest rates than a $1,000 CD. The smaller the institution, the more likely the interest rate will be higher, and uninsured banks tend to offer the highest rates. 

Opening / Closing a Term Deposit / CD

While they're called certificates of deposits, few who open a term deposit actually receive a certificate. Though it used to be the case that a person would receive some form of certificate, usually a term deposit just appears as a book entry in a bank statement. Paper statements can still be requested, where the principal, interest rate, and duration as agreed by the lender and financial institution. 

Closing a term deposit before the end of the term, or maturity, comes with the consequence of lost interest on the principal. The penalty for withdrawing prematurely or against the agreement is stated at the time of opening a term deposit, as required by the Truth in Savings Regulation. Sometimes, if the financial environment is right and interest rates have risen a considerable amount, the penalty a financial institution may not be enough of a deterrent for an investor to withdraw their term deposit and refinance it at a higher rate. 

When a term deposit is reaching it's maturity date, the financial institution that has been holding the investor's principal will usually send a letter asking for direction on what steps to take. The steps an investor can take are either withdrawing the principal originally invested with the institution, or they can let it roll over. If the holder gives no instruction, the institution can reinvest that money.

Investment strategies

One strategy for investing term deposits is to distribute an investment evenly over a set number of years in long-term CDs. This strategy locks in higher interest rates due to the investment in longer term CDs while also making it so a part of the lump investment matures regularly. 

For example, if an investor deposits $3,000 in a 5, 4, 3, 2, and 1-year term deposit, each year the investment will reach maturity. This strategy can be used while investing with the same credit union or bank, or across a few different institutions. The investor can either recoup the principal and the interest and keep it, or they can then re-invest in another 5 year term deposit. Financial institutions aren't responsible for the management of a ladder investment strategy, the investor is. 

Drawbacks of CD's

On term deposits, interest rates can track inflation rates, making it so any gain on the principal is in fact not a gain in value but simply a gain in capital. However, the issue is not whether or not term deposit track inflation, but how closely they do. This can be to the benefit or disadvantage to the investor. If the projected inflation rate is high, and inflation goes below what is expected and the interest rate on the principal invested is locked in, then the investor stands to gain value on the term deposit. If the inflation rate ends up going higher than anticipated and the interest rate isn't adjusted, an investor could lose value on their investment. 

Outside of inflation, term deposits with wildly high interest rates have been used in the past to draw in participants into ponzi schemes. 

RELATED TERMS
  1. Deposit Interest Rate

    The interest rate paid by financial institutions to deposit account ...
  2. Bank Deposits

    Money placed into a banking institution for safekeeping. Bank ...
  3. Dual Currency Deposit

    A fixed deposit with variable terms for the currency of payment. ...
  4. Foreign Deposits

    A deposit made at, or money put in to, domestic banks outside ...
  5. Call Deposit Account

    A bank account for investment funds that offers the advantages ...
  6. Deposit In Transit

    A deposit in transit is money that has been received by a company ...
Related Articles
  1. Savings

    Where To Put Your Cash: Call Deposit Vs Time Deposit Accounts

    Time deposit accounts and call deposit accounts allow customers to earn higher interest in exchange for less access to their cash.
  2. Bonds & Fixed Income

    Certificates Of Deposit: The Basic Model

    A certificate of deposit is not a physical piece of paper issued by a bank or credit union. It is an account set up under certain terms. The basic elements include the amount of deposit, the ...
  3. Investing Basics

    What is a Bank?

    A bank is a financial institution licensed to receive deposits or issue new securities to the public.
  4. Retirement

    Money Market: Certificate Of Deposit (CD)

    A certificate of deposit (CD) is a time deposit with a bank. CDs are generally issued by commercial banks but they can be bought through brokerages. They bear a specific maturity date (from three ...
  5. Savings

    Find the Best Savings Account Rates

    You know how to spot the highest interest rate, but how do you really get the best deal on savings accounts?
  6. Stock Analysis

    Refocusing on Deposits

    Investment banking is in search of new profits and liquidity under commercial banking rules.
  7. Budgeting

    The 7 Best Places To Put Your Savings

    You work hard to put your money away for the future, but where you should you keep it?
  8. Retirement

    Analyzing The Best Retirement Plans And Investment Options: Cash Investments

    What they are: Low-risk, short-term obligations that provide returns in the form of interest payments. Pros: Low- to no-risk; easily redeemable; often FDIC insured. Cons: Withdrawal penalties ...
  9. Insurance

    How the Federal Deposit Insurance Corporation (FDIC) Works

    Learn more about the Federal Deposit Insurance Corporation (FDIC) and what happens to your deposits over $250,000 if a member bank fails.
  10. Investing Basics

    Analyzing A Bank's Financial Statement

    Investors should analyze a bank’s interest rate risk and credit risk when analyzing its financial statement.
RELATED FAQS
  1. Besides a savings account, where is the safest place to keep my money?

    Savings accounts are safe because investors' deposits are guaranteed by the Federal Deposit Insurance Corporation (FDIC) ... Read Answer >>
  2. How safe an investment is a certificate of deposit?

    Discover certificates of deposit, their basic makeup and numerous variations, and understand why they are some of the safest ... Read Answer >>
  3. What are the typical durations for a certificate of deposit?

    Investing in a certificate of deposit offers individuals the ability to earn interest on idle funds with less risk than stock ... Read Answer >>
  4. What determines the interest rate in my money market account?

    Placing funds in a money market account may provide a higher interest rate than a savings account due to the underlying securities ... Read Answer >>
  5. Are certificates of deposits different from money market demand deposits?

    What are the differences? ... Read Answer >>
  6. Are my investments insured?

    No. Whenever you invest in a stock, bond or mutual fund, there is no insurance against the possible loss of your initial ... Read Answer >>
Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center