Deposit Accounts: Understanding Certificates of Deposit

by Amy Lillard

(2/24/2013) For those looking to maximize their savings, and willing and able to leave the money untouched for an extended amount of time, certificates of deposit (CDs) are an effective tool.

Consumers who open CDs put money into this account for a specified period of time (known as the maturity date), and in return will earn a guaranteed interest rate. CDs and their maturity periods can range from a few weeks to several years. Generally, the longer the term of the CD, the higher rate of return you will receive. Longer maturity terms allow banks to invest the money in long-term investment vehicles, thus earning the higher rates.

The major benefit of CDs is the significantly higher and fixed interest you can earn over time. Rather than typical savings accounts, which will offer interest rates at the low end of the market, CDs will provide higher returns.

In addition, many CDs featuring compounding interest. Each month, the CD will pay out 1/12th of the year's interest, and add it to the principal in the account. Each month, then, the balance that is earning interest increases, which also increases the amount of interest earned. This feature adds up quickly and provides an even more powerful way to maximize the money you save.

The major drawback of CDs is the high penalties for early withdrawal. Savers who withdraw their money before the CD matures will need to pay at least several months of interest, if not more. For that reason, CDs are recommended as an addition to a regular savings account, from which savers can easily make withdrawals when needed without penalty.

When buying a CD there are multiple types to choose from, and a variety of places to look. From your local bank branch to online deals, the choices of terms and rates are many. With each, however, know that you can cash out when reaching the maturity date, or rollover the funds into another CD to continue increasing your funds. Overall, CDs are a savings tool with more restrictions than typical savings accounts, but also provide higher yields. Know also that CDs are safe, with insurance provided by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per individual.

For Additional Reading:

Certificates of Deposit:
http://banking.about.com/od/cds/CDs_Certificates_of_Deposit.htm

Certificates of Deposit: Tips for Savers
http://www.fdic.gov/deposit/deposits/certificate/