A:

A certificate of deposit, or CD, is an extremely safe investment, earning a guaranteed rate of interest and insured by the Federal Deposit Insurance Corporation, or FDIC, or the National Credit Union Administration. However, dispensing with risk, the guaranteed return and safety also means dispensing with any potential for large reward. CDs earn a comparatively very low rate of return on investments.

About the only investment that a CD outperforms in regard to rate of return is a standard passbook savings account or an interest-earning checking account. A CD is, in essence, a promissory note that you get from a bank, brokerage firm or credit union. CDs are for a fixed amount of money, with a fixed rate of return. Although the rate of return is slightly higher for larger deposits or deposits made for longer time periods (time frames for CDs typically range from six months to five years), the interest rate paid on CDs is typically around the same level as the recent inflation rate as measured by the consumer price index, or CPI, (as of this writing, just over 1%). Because a higher interest rate is paid in return for a longer deposit term, CDs often carry severe penalties for early withdrawal.

There are some variations available in CDs, such as those that offer no penalty for early withdrawals, but they most commonly involve the trade-off of accepting an even lower interest rate than usual in return for the extra. Some banks offer bump CDs, which feature the opportunity to go in once during the life of the CD and adjust the interest rate in accord with current rates. There are limitations, however, and the trade-off usually means accepting a lower starting interest rate.

One way to maximize the rate of return on a CD is to opt for more frequent calculation and payment of interest. Compounded quarterly or semi-annual interest noticeably increases the payout over that of a CD with interest only calculated once annually.

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