What is a CD Account?

A CD, or certificate of deposit is a popular way to invest your money safely. Here's a look at just what is a CD account.

What is a CD Account

What is a CD AccountA certificate of deposit, or CD, is a type of low-risk investment that many people use when they want a small return on their investment without having to worry about losing their money. A CD is a deposit account that has higher interest yields than a savings account but lower yields than stocks.

A CD is a fixed investment for a fixed amount of time at a fixed interest rate. For example, you might invest $10,000 in a CD for one year at 4.99% interest rate. The bank pays interest on the investment at certain periods throughout the investment. For example, your interest may be paid bi-annually, then at maturity. Or, for short investment periods, interest may only be paid at maturity. (Note: there are variable interest rate CDs with fluctuating interest rates)

CD Insurance Limits

One of the major benefits of investing in CDs is that they can be FDIC insured up to $250,000 (until December 31, 2009). That means your investment and earnings are safe up to the FDIC insured limit as long as your money deposited at an FDIC enrolled bank. CDs purchased from credit unions are also insured when the bank is a member of the National Credit Union Administration (NCUA).

Married couples can increase their CD coverage limit at a single institution by having a joint CD plus individual CDs. Other investors who do not have joint accounts can increase coverage limits by opening CDs at several different banks.

Purchasing a CD

CDs pay higher rates in exchange for your promise to leave your money in the account for a certain amount of time. If you cash in your CD early, you will probably face an early withdrawal penalty, forfeiting some or all of the interest you earned.

You can purchase a CD directly from a bank or through a brokerage firm. Brokerage firms pool together CD investors and are often able to offer the best CD rates. That’s because these brokers have negotiated higher rates with the bank in exchange for bringing a greater number of customers. If you purchase a CD through a brokerage firm, it’s important to know the bank the CD will be purchased through and whether the bank is FDIC-insured.

How to Choose a CD

CDs may have a minimum deposit amount. This is the amount you must deposit to purchase a CD. Minimum deposits are typically somewhere between $500 and $1,000. You won’t be able to open a CD if you don’t have at least the minimum deposit amount.

Make sure you understand penalties associated with the CD – under what circumstances would you receive a penalty and how much the penalty would be. Generally, banks are allowed to set their own limits for penalties, so it’s a good idea to compare penalties among various banks.

Decide how long you want to invest your money. The longer you keep your money in a CD, the higher interest rate you can earn. There are short-term CDs with maturity dates between 30 days and 12 months. Then, there are long-term CDs with maturity dates greater than 12 months. Choose a long-term CD only when you’re sure you won’t have to access the money soon. You may wan to consider a fixed annuity if you have a longer time horizon. Fixed annuities often pay competitive rates when compared to CD’s. However, they do not offer FDIC protection, though they are guaranteed and backed by the issuing insurance company.

When your CD expires, you’ll have the option of reinvesting the funds or withdrawing the money. If your CD has automatic rollover, you only have a few days to make this decision, so you have to let the bank know in a timely manner. Waiting too long could result in your money being reinvested into a CD, making it inaccessible except if you pay a penalty for early withdrawal.

Understand whether your CD has a call feature. This feature allows the bank to terminate your CD at will. When this happens you’ll get your money plus unpaid interest that’s accrued on the investment, but you’ll have to find another CD if you want to reinvest your money. Banks might call a CD if interest rates have fallen. Some CDs have a call period in which the bank may not call the investment.