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.

RELATED FAQS
  1. 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 >>
  2. How are yields taxed on a certificate of deposit (CD)?

    Learn how interest earned on a certificate of deposit is taxed and how this may reduce the total return of an investment ... Read Answer >>
  3. What is the safest investment?

    Learn about some of the safest investment types. Find out which investment categories offer the best protection on your principal ... Read Answer >>
Related Articles
  1. Investing

    Are CDs Good Protection For The Bear Market?

    Certificates of deposit promise stable income in any market, but do they deliver?
  2. Investing

    Getting Certificates of Deposit (CDs) in Emerging Markets: Risks and Rewards

    Learn about the risks and rewards associated with investing in a certificate of deposit (CD) offered by an emerging market and what to consider before buying.
  3. Investing

    How To Earn The Most From CDs When Interest Rates Are Low

    Certificates of deposit might not seem like a good place to keep your money when interest rates are low, but they do offer security and stability. And with laddering and studying promotional ...
  4. Investing

    Should CDs Be a Thing of the Past?

    Certificate of deposit rates remain low. Are there better alternatives?
  5. Managing Wealth

    How To Create A Laddered CD Portfolio

    Laddered certificates of deposit offer safe capital and predictable cash flow, while bringing simplicity to your portfolio.
  6. Managing Wealth

    Save Smart With A CD Ladder

    A CD Ladder allows you to stagger your investments and take advantage of higher interest rates.
  7. Investing

    Long-Term Investing With Equity Index CDs

    Equity Index CDs are perfect for investors who don't mind hanging in for the long term.
  8. Investing

    Money Market vs. CDs: Which Is the Better Investment?

    Find out which short-term savings vehicle, a money market account or a certificate of deposit, is a better investment for your needs.
RELATED TERMS
  1. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. ...
  2. Bull CD

    A certificate of deposit whose interest rate fluctuates in direct ...
  3. Indexed Certificate Of Deposit - Indexed CD

    A savings certificate entitling the bearer to receive an interest ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, ...
  5. Time Deposit

    A savings account or certificate of deposit (CD) held for a fixed-term, ...
  6. Inflation-Linked Certificates of Deposit

    Federally insured debt securities that are similar to regular ...
Hot Definitions
  1. Absolute Advantage

    The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost ...
  2. Nonce

    Nonce is a number added to a hashed block, that, when rehashed, meets the difficulty level restrictions.
  3. Coupon

    The annual interest rate paid on a bond, expressed as a percentage of the face value. It is also referred to as the "coupon ...
  4. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are considered socially conscious because of the nature of the ...
  5. Letter Of Credit

    A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. ...
  6. Multiplier Effect

    The expansion of a country's money supply that results from banks being able to lend. The size of the multiplier effect depends ...
Trading Center