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Introduction |Buying CDs |CD Interest, CD Yield
Floating and Flexible Rates |Renewing a CD |Pluses and Minuses of CDs
When you buy a Certificate of Deposit (CD), you invest your money at a guaranteed interest rate for a specific period of time. If you want to invest with the least risk, you might consider a CD.
If you want to invest with the least risk, you can consider a CD. Since bank CDs are FDIC-insured to a cap of $100,000 per depositor per bank, you don't have to worry about losing your money. You always get back the amount you put in, plus interest.
The drawback is that you must leave your money on deposit for a specific period of time or pay a penalty for early withdrawal. But you can pick the term, the amount of time you want to invest -- from a month to 5 years. The most popular terms are six months and one year.
Lenders may be flexible, though, if you ask for special terms. For instance, if you owe a tuition payment in 7 months, you may be able to get a custom 7-month CD, at a better rate than the regular 6-month CD.
You can buy a CD at almost any bank or from your broker.
A bank will sell you a CD for any amount of money, for any of the terms they offer.
Brokers buy huge CDs and then divide them into smaller pieces to sell to individual investors. Because you buy only part of a CD, you aren't locked into holding it until maturity. That means you can get your cash if you need it, plus the interest you've earned, without paying a penalty. The tradeoff for this flexibility may mean paying a commission (banks don't charge commission). But you may also earn more on your investment.
finding the best cd What makes one CD better than another is the amount you earn.
This chart, which appears monthly in The Wall Street Journal, lists the best rates offered nationally on CDs of different terms. Generally, the longer the term, the higher interest a CD pays, but that's not always the case. Some banks offer higher interest on CDs with shorter terms, especially if they're not sure which way rates are going and they want your business now.
Yield is what you earn, and it's based on the interest a CD pays.
What you actually earn on your CD, in dollars and cents, is the yield or the annual effective yield. The seller has to tell you what the yield will be--but don't confuse it with the interest rate.
To calculate yield, you have to know the interest the CD pays and whether it is simple or compound.
Simple interest pays you a straight percentage -- for example, a $10,000, one-year CD paying 9% would yield $900. But if the interest is compounded quarterly, the yield would be $995.12.
Banks sometimes offer variations of the standard CD to attract business.
If you're reluctant to put money in a CD because the rates are low, banks may be offering flexible or floating rates, or may let you select a new rate--presumably a higher one--once during the term of the CD.
A flexible rate moves up and down with market rates, but usually comes with a floor--or limit how low the rate can drop. A floating rate is pegged, or linked, to some other rate, like the one a U.S. Treasury Bill is paying, and can also go up or down.
When a CD matures, you have to decide what to do with it.
When your CD matures, the bank usually rolls over, or reinvests, your CD into a new one of the same term, at whatever the current rate of interest is. If you want to withdraw your money, you usually have to let the bank know in writing by a specific deadline. Or you can tell the bank to sweep, or move, your money into another account.
The danger is forgetting about the CD, and having it automatically reinvested at a lower rate than you could earn elsewhere.
CDs have big advantages, but some real limitations.
pluses
- Your investment is insured up to a total of $100,000 per bank.
- The yield is higher than on other bank accounts.
- Knowing what you have and when you can take it out lets you plan for future cash needs.
- You can get very good yields when banks want cash to make loans.
- You pay no charges for a bank CD.
- Changing economic conditions do not affect what you earn during the term of the CD.
minuses
- Your money is locked in at a specific rate, even if interest rates go up.
- You pay large withdrawal penalties if you take your money out early .
- You may earn more with other, non-bank options.
- CD interest is taxable.
- The new interest rate when you reinvest (or roll over) your CD may be lower.
- If your bank is taken over by another bank, your CD term or rate may change.
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