What is a CD?

CDs, or certificates of deposit, are financial instruments offered by many banks, credit unions, and other types of thrift institutions. The certificate of deposit provides the consumer with the ability to deposit a specific sum into a deposit account. In return, a competitive rate of interest is applied to the balance. Classified as a time deposit, the CD is assigned a maturity date, with the accrued interest applied at the point of maturity.

The CD is considered an excellent way to begin a savings program. Like the standard savings account offered by most banks, the bank CD is a relatively low risk investment, with almost no chance of losing money on the venture. However, bank CDs tend to carry a higher interest rate than even the best savings accounts, making it more attractive to anyone who prefers safe investing but wants to earn more on the deposited balance.

Establishing a CD with a local bank or other financial institution is an easy task. The account is opened, and a specified amount is placed into the account. Most banks have a minimum amount that must be placed into the account at the time the CD is established. Along with making the deposit, it is necessary to select a fixed amount of time for the account to accrue interest. Most plans of this type call for anywhere from six months to two years. Once the account is established, withdrawing funds from the CD is very difficult to accomplish, and carries substantial penalties.

When the maturity date is reached, the total amount can be rolled over into a new CD, allowing the process to begin once more. However, it is not unusual for bank customers to have the interest earned transferred into an account where those funds are readily available, such as a checking or savings account. The principle is rolled into another CD with a new maturity date, making it possible to continue earning interest on those funds.

Many investors who favor the use of certificates of deposit will establish several of these accounts, each with a unique maturity date. If arranged properly, it is possible to earn interest income that becomes available several times a year. This can be especially helpful when seeking to create a small but consistent source of income without spending the principle sum used to generate the interest.

Because of the competition among different financial institutions, it is possible to shop for the best interest rates before establishing a CD with any one institution. Generally, the rates of interest will be higher for certificates of deposit that carry a longer duration until maturity. For people who can reasonably expect to not require the funds deposited into the account for a longer period of time, going with a medium-term rather than a short-term certificate of deposit is an excellent option.