Advantages of a Certificate of Deposit

If you want a low-risk method of earning interest, a certificate of deposit, or CD, may be a good investment for you. Certificates of deposit work well if you have funds that you will not need for a period of time. Offering safety and often a higher rate of return than a savings account or money market account, a CD is easy to open and simple to maintain.

Identification

Certificates of deposit are bank investment instruments that carry a fixed interest rate and are held for a specified length of time. As opposed to market-based investments, such as mutual funds or annuities, which carry risk because they are tied to the fluctuations of the stock market, CDs offer an effective means of earning a return on one's money. Because CDs are bank deposits, they are insured by the Federal Deposit Insurance Corporation, or the FDIC.

Function

When you purchase a certificate of deposit, you make an investment in a bank. The bank will use that money to invest in profitable ventures such as issuing mortgages or making loans to businesses. As an investor, you earn a return in the form of interest. Because many banks want your investment, they must compete for your business, giving you the freedom to shop for the best rate.

Time Frame

The term of a certificate of deposit can range from three months to five years or longer. The longer the term of the CD, the higher the rate you should expect to receive. Also, the more money you invest, the higher the rate of return. Be sure you won't need the funds you are investing until the CD matures. Contact the bank prior to the maturity date to discuss whether you want to renew the CD for a new time period, or withdraw the funds. Ask what the rate will be if you decide to renew. Once the CD matures, you are under no obligation to renew and stay with the bank that issued the CD. If you find a higher interest rate at a different bank, reinvest your money there to receive the best return.

Benefits

You may invest in a certificate of deposit without using a broker. An investment broker may offer to find you a CD with the best rate and may charge you a commission. But paying a broker to simply locate the highest interest rate and write up a CD contract effectively lowers your rate of return. Instead you may take out your CD directly from a bank. Call a few banks and ask what rate of interest they are offering or visit a few bank websites for the same information. See the resource box below for a comprehensive look at CD rates around the country.

Considerations

Make sure you understand all the rules before investing in a certificate of deposit. For example, if you withdraw your funds before the maturity date, you may lose some of the interest you have accrued to date. Also, yearly earnings on a CD are taxable unless they are held in a retirement account. If those earnings are substantial, they could move you into a higher tax bracket. Seek tax advice if you're not sure how your CD earnings will affect you.

Resources

• Comparison shop for CD rates.