A certificate of deposit (CD) is a type of investment which is similar to a traditional deposit. With a CD, you place a certain amount of money into an account for a specific period of time and wait for it to “mature.” When your deposit matures, the banking institution where your CD money is held returns your investment to you, plus interest.
The difference between a CD and a traditional deposit is that, typically, you agree not to touch your CD deposit money for a specific amount of time. Banks reward you for leaving your CD untouched by paying you at a higher rate of interest than they would if you had made a traditional cash deposit.
The Types of CDs
There are a variety of CD options. In addition to traditional CDs, the Wall Street Journal recognizes the following types:
- Liquid: You can make early withdrawals without being punished, but you can only withdraw previously agreed-upon amounts. The return on investment for these CDs is typically much lower than that of a traditional CD.
- Zero-Coupon: Although you generally receive annual interest payments when you hold a traditional CD, your annual payments do not apply to Zero-Coupon CDs. Instead, the payments you would have received each year are reinvested into the CD, which means that over time, you usually receive higher earnings.
- Callable: A callable CD is one that a bank can “call” or end after a certain period of time has passed. You might not be able to earn as much interest as you would prefer.
- Brokered: These CDs are obtained through a broker, much like stocks. They can be appealing because brokerages sometimes offer more competitive rates than banks. They are also different from the CDs you typically buy from banks because you can trade them.
Evaluating the Certificate of Deposit
A CD may be a more attractive choice for some investors than others. If you want a safe place to invest funds you will not need in the immediate future, you will find that investing in a CD can be an excellent decision. With CDs, your principle is guaranteed; they are considered one of the safest types of investments, especially when federally insured and non-callable.
On the other hand, if you believe you may need to withdraw money from your account before your deposit matures, you may not find a CD to be your best option. Banks typically charge steep penalties for early withdrawals.
CDs may also be unattractive to some investors because they offer low interest rates compared to other forms of investment. Forbes states that the average interest rate paid out on a three-year traditional CD is only 0.46 percent. Other forms of investment, including peer-to-peer lending and annuities, can be riskier, but they often have higher returns on investments. If you are willing to take greater risks for higher profits, you may also want to consider investing in stocks or municipal bonds, which can average returns on investments over 3 percent.
For higher returns on investments, consider investing in a brokered CD. Keep in mind, though, that the performance of these CDs can be variable; investing in them may be slightly more risky than investing in a traditional CD, but they can lead to returns on investments of up to 6 percent.