Investing Savings

What is a Certificate of Deposit? (CD) Complete Guide

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Parking your money in a Certificate of Deposit, or CD is a great way to earn a risk-free return. A certificate of deposit is generally the highest yielding investment that banks offer, and they are both reliable and convenient.

The idea behind a certificate of deposit is simple.

All you have to do is agree to deposit your money with a bank for a given amount of time (called the ‘term’ of the certificate of deposit), and the bank will give you a much higher interest rate than a normal savings account.

Simple right?

There are numerous ways to invest in CDs. Banks have also introduced new kinds of CDs, which can help you to be a little bit more flexible when it comes to how you invest your cash. There are also a number of other options for fixed-income investors, some of which could be a better fit than CDs.

A Certificate of Deposit is a Safe Bet

In the world of fixed income investing, a certificate of deposit is one of the safest ways to make a return on your money.

As long as the bank or credit union you do business with is insured by the FDIC (banks), or the NCUA (credit unions), your deposits will be insured to the amount of $250,000 USD.

Even if the bank went bankrupt, your money would still be covered by a US government deposit insurance program.

It is good to remember that the deposit guarantee will apply to the institution, and not to the individual account or certificate of deposit. This is only a concern for high net worth individuals, who have more than $250,000 to invest.

If you have more than $250,000, and you want to keep it in certificates of deposit, you can just use more than one bank. You should be able to claim $250,000 in coverage per financial institution in the event of a widespread financial meltdown.

What Are My Options for a Certificate of Deposit?

Classically, a certificate of deposit was a straightforward agreement. The depositor would elect the term of the CD they wanted to buy, and an interest rate would be applied to the transaction. The longer the term, the higher the rate.

Now there are a few more options to choose from. Some of the new CDs blur the line with a money market account, which is another way to earn a higher rate of interest than a normal bank account would yield.

Liquid (or ‘No Penalty’) Certificate of Deposit

Banks are offering liquid CDs that allow depositors to access their money at any time during the term of the deposit. Normally, when you wanted to take your funds out of a CD early, it would be necessary to pay the bank a penalty to get your money back.

A liquid CD could make sense for numerous reasons, especially if it was offering an interest rate that was higher than a savings account. If you are interested in opening a liquid CD, keep in mind that there aren’t any industry-standard terms, so you need to do your research before you deposit your money.

Liquid CDs will probably never have as high of an interest rate as a normal CD, but you can likely move your funds from a liquid CD to a normal CD at any time, at least as long as the bank’s terms and conditions allow it.

Bump-Up and Step-Up Certificates of Deposit

Bump-up and step-up CDs allow depositors to move up to a higher interest rate in the event that rates rise after the CD is opened. This sort of CD is made for an environment where rates are rising and would be a poor choice if rates are static or falling.

Every bank will have a different set of offerings, and you need to know how things work at the bank you choose. If you want to open up a bump-up or step-up CD, make sure you know how the system works before you commit your cash to the CD.

Brokered Certificates of Deposit

Many banks broker certificates of deposit for other banks. The upside for depositors is that you can shop among a wide range of CD products, and find terms that work for you.

On the downside, getting in and out of a brokered CD is probably going to be more difficult than dealing with your bank directly. You may come across CD’s that aren’t insured by the FDIC or NCUA, which means you would have zero protection if the bank went broke.

If you decide to shop around the brokered CD market, make sure you learn as much as you can about the banks you are dealing with. A great rate doesn’t mean much if you never see your money again!

Jumbo Certificates of Deposit

As the name suggests, a jumbo certificate of deposit is for people with a lot of cash to park in a CD. The rates that jumbo CDs offer will be higher than the regular offerings, but they may have minimum investments of $100,000 USD or more.

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The Certificate of Deposit Ladder Strategy

One of the downsides of CDs is that they lock up your money for months, or years at a time. You will earn a higher interest rate because of your commitment to the bank, but it can be a real pain if you have to pull out of a CD with a three-year term because you need the money.

Another reason why the CD ladder strategy makes sense is that interest rates can rise. This probably isn’t the case right now, but it is worth understanding the strategy nonetheless.

A CD ladder refers to the practice of breaking up your principle and spreading it over multiple CDs that all have different terms. It is a good way to gain a higher return on your cash, and not have to keep all of your money locked up for years at a time.

How a CD Ladder Works

Let’s say that you have $50,000 that you want to invest in CDs. If you wanted the absolute highest return on your money from a CD, you would need to put it all in a CD with a long term.

Instead of locking up your money for five or more years, you can start by putting a portion of your capital into a short term CD (six months), another portion into a medium-term CD (one year), and finally some into a longer-dated CD (three years+) that will give you a higher interest rate.

For the sake of a simple explanation, we are going to use a simple CD ladder. It could be more complex, based on how you want to structure it.

So, let’s say that six months have gone, by, and you don’t need any of the money that has just matured. You have the option of buying another 6 month CD, or you could commit to a year, as you will have another CD hitting maturity in just six months.

If you decide to buy a one year CD, it will mature just six months after your initial one year CD does, which means that you can then shift to buying year-long CDs, but have access to your cash every six months.

Pretty cool, no?

Of course, the whole time you are rolling over your short and medium-term CDs, your long term CD will be racking up the returns. At the end of three or five years, you will have earned a lot more than a regular savings account could have delivered!

Interest Rates Are Likely to Fall: The Challenge for CDs

Most of the options for CDs that are outlined above are built to take advantage of rising interest rates. The next few years could see interest rates to fall to zero (or even below), which makes investing in CDs a little bit more difficult.

The above-mentioned CD ladder strategy works a lot better when interest rates are static, or even better, rising. When they are falling, it is likely that the overall level of return would drop whenever a CD was rolled over.

Falling rates could knock down the effectiveness of rolling over shorter-term CDs, which makes locking your money up in a longer-term CD look much more attractive.

The clear downside to using longer-term CDs is access to your cash.

There isn’t a simple solution to falling rates for fixed income investors. If yield is important to you, it would be a good idea to consider locking in today’s relatively high-interest rates, before the entire market moves against anyone who needs to make income from their money.

Other Fixed Income Options to Choose From

A certificate of deposit is a very safe way for fixed-income investors to tap into the interbank lending market. When they were created people didn’t have many other options, unless they wanted to invest in government bonds.

Today, there are numerous ways for people to gain access to safe, interest-bearing investments. Keep in mind that the safety that CDs have isn’t really created by the bank. It is created by the government-baked deposit guarantee.

Bond Funds

Bond funds invest in government and commercial bonds.

A short term government bond fund would arguably be safer than a CD, though it is likely to yield less. Buying longer-dated government bonds via a bond fund could also be a way to hedge your other fixed-income investments, as the value of long-dated bonds tends to rise as interest rates fall.

Money Market Accounts

Money market accounts (not money market funds) are like an extremely flexible CD, though the interest they pay generally isn’t as high. On the plus side, money market accounts let you have access to your money frequently, and some even offer a debit card.

Savings Account at an Online Bank

Over the last decade, numerous new online banks have entered the marketplace. These banks don’t have brick-and-mortar operations, so their overhead is super low.

As long as the bank is FDIC insured you will be getting the same level of deposit insurance as any other bank, and the interest rates online banks offer for their savings accounts can be much higher than retail banks.

Another advantage of using a savings account at an online bank is access to your money, as it won’t be locked into a CD for long periods of time.

Are CDs a Good Choice for You?

A certificate of deposit is a good way to save, especially if you want to lock in the interest rates that are on offer at the moment. The big downside to CDs is access to your money. If you think you will need to use the money you want to invest in a CD, it might be a good idea to look at other options as well.

Using long-dated CDs is a good way to create reliable income, and insulate yourself from any changes in interest rates. If you have a lot of money that you don’t need to have easy access to, CDs are a great tool to create reliable returns.

A Certificate of Deposit Could Fit in Your Financial Plans

If you are looking for a secure investment that is insured by the government, a certificate of deposit could be a good fit. There are many different kinds of CDs to choose from, so be sure to shop around before you commit your money to a multi-year term.

Don’t ignore the online banking space, as the lack of overhead allows these upstart banks to offer rates that are substantially higher than established institutions. As long as the bank or credit union is backed by the FDIC or NCUA, your money is safe.

CDs can also be used as a tool in a wider portfolio, and as long as you have less than $250,000 in any given financial institution, the level of counterparty risk is extremely low. Keep an eye on what interest rates are doing, and make as much as you can without taking on much risk!


Nicholas is an experienced Finance Journalist who has written for a number of prominent online publications. He grew up in Ann Arbor, Michigan with a father that would read him the Wall St. Journal along side of other bed-time fare. He has traveled extensively, and been lucky enough to study a changing global economy in person. Nicholas spent many years in the Southern Cone of South America, sometimes in the middle of the countryside where livestock starts its journey to all points of the globe. Today he is thoroughly bemused with the stance that Central Banks have taken in the wake of the 2008 meltdown. There is no telling what will come out of the global financial system next, but he is glad that he lives somewhere that gold can be bought and sold readily!

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