I am about to reveal something both cool and nerdy about myself: I’ve known about certificates of deposit (CDs) since I was around 10 years old.
My grandfather opened one in my name when I was that age, and he took me along with him to the bank. I kept the printed receipt from that exchange, and when I got home, I tucked it carefully into the top drawer of my bedroom desk. I didn’t know the details of what had gone down at age 10, but I knew that the bank was an important place and that the paper stood for something important. I knew that I had money, and I wanted to make my grandfather proud by hanging on to the piece of paper that proved it.
While I don’t still have that paper receipt, I do still have a healthy respect for CDs. They serve many purposes. They can be a great tool both to introduce people to money management or to snag a higher interest rate than you’ll find on just about any regular savings account.
Let’s dive into the details of a CD and see what kind of accounts they are and who they’re good for.
What Is a CD?
“CD” stands for “certificate of deposit.” A CD is a savings account that you can open for a set amount of time with a fixed interest rate. CDs usually offer higher interest rates than regular savings accounts, but they come with more rules too.
CDs can be issued for various amounts of money. Banks and credit unions can set their own minimum requirements. CDs are insured by the FDIC like other savings accounts, up to $250,000 per individual. Once you open (buy) a CD, you can’t withdraw money from the account without facing penalties. This is one of the biggest differences between a CD and a regular savings account; the money isn’t liquid (easily available).
The money goes into the CD and stays there for the set amount of time. Most financial institutions offer CD terms in multiples of six months. So you can open one for six months, 12 months, 18 months, etc. Usually, the longer the term length, the higher your interest rate.
So, as an example, you might take $5,000 and put it in a CD for 18 months at 1.25% interest rate. Once the account has been opened, you can’t take money out of the CD for the next 18 months without incurring a penalty.
When I was a kid, you had to open your CD in person. Today, you can open a CD online. Check with your bank or credit union on their specific requirements for opening a CD.
Types of CDs
There is more than one type of CD. Let’s break them down.
- Small CDs: CDs of less than $100,000.
- Large or Jumbo CDs: CDs for more than $100,000.
- IRA CDs: Instead of transferring money to a CD from your checking account, you open one using funds from your IRA.
- Bump-up CDs: These allow you to request a higher rate if your bank increases its annual percentage rate (APR). Generally you’re allowed to ask for only one interest rate bump with these accounts.
- Step-up CDs: With this type of CD, your account receives periodic rate increases, where the APR on the CD automatically goes up.
Pros of a CD
CDs are a safe place to keep your money as far as bank accounts go.
- High interest rates
- FDIC insured accounts
- A low-risk option for money
Cons of a CD
CDs come with low risk, but that means they don’t come with high returns. If you’re interested in growing your money substantially, you should look into investing in the stock market.
- Set term lengths prevent you from accessing the money freely
- Penalties for early withdrawal
- Not good for high return rates
Who They’re Best For
CDs are great options for many different financial situations and people.
They can be a way for parents (or grandparents!) to introduce their child to saving money and general money management. Opening a CD with your child can show them the power of interest over time, as well as impress upon them the need to have savings for the future.
CDs can also be a great tool for someone who is looking for a higher interest rate than a regular savings account offers. For example, someone who is looking to buy a house in the next 15 months might consider keeping their down payment funds in a CD for six or 12 months to take advantage of the higher interest rate. If you don’t need immediate access to the money, a CD is a good chance to earn more money on interest.
They’re also a good option for someone who has a very low risk tolerance or someone who is brand new to managing their money. CDs allow people to put their money in a secure situation but still cash in on some of the better interest rates at banks. A college student might consider opening a CD in their freshman year, letting the money grow throughout college, and then using the accrued money to kick-start their student loan payments after graduation.
Since the money is essentially untouchable once it’s in a CD, they’re also a good chance to learn about delayed gratification. I appreciate CDs so much in this way; if you have a short- or mid-term goal, a CD can be a big benefit. You can earn a decent interest rate while also protecting your savings from yourself. There’s much less of a chance that you’ll spend the money in a CD than the money in your more easily accessible savings account.
CDs are a great financial teaching tool, as well as a safe option for savings. They can round out a financial portfolio and provide a stable place to keep some of your assets. But they won’t give you higher interest rates than the stock market might achieve, and once your money is in a CD, it’s hard to get it out. CDs should be part of broader portfolio or used as a teaching tool for those just beginning to handle money.