A CD,
or certificate of deposit, is a financial product offered to consumers
by banks, credit unions, and other lenders. A CD is similar to savings
accounts in that they are both savings vehicles and insured by the
FDIC.
CDs are different from savings accounts because when CDs are opened,
the money is contracted to be held by the bank for a specific period of
time. CD lengths vary from a few months up to five years. A CD normally
has a fixed interest rate for the entire length of the commitment, and
the consumer is not available to add or withdraw funds from the
account.
Buying a CD is a simple process. Almost all lending institutions offer
a variety of CD products, and will advertise CD rates on their website.
Since CD’s are risk free for the banks, there is just a short
application process prior to opening. The consumer should research
online for the best CD rates available, as rates can vary a good amount
between lending institutions.
In general, CD interest rates are higher for individuals who open
larger CD accounts, accept longer periods until maturity, or accept a
CD from a non FDIC insured institution. Opening a longer term CD is
somewhat risky because interest rates may increase over time, causing
the CD consumer to miss out on higher interest products. Simply closing
a CD account if rates increase prior to maturation will lead to a
penalty as high as 6 months interest.
To hedge against the risk of increasing rates, many CD investors will
follow a “CD ladder” strategy. In a CD ladder strategy, a CD investor
will open various CD’s with different maturity dates, which essentially
diversifies the investor from accepting any current market rate.
Some lending institutions offer unique CD products including Bump UP
CDs, Liquid CDs or Variable CDs. Bump up CDs allow the saver to
increase the interest rate to market rates once during the term. Liquid
CDs allow the saver to withdraw a portion of the CD penalty free.
Variable CDs rate fluctuate with a specific index, such as CPI, the
S&P 500 or T-Bills.
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