About Investment CDs

Contributor

By W D Adkins
eHow Contributing Writer

Article Rating: (0 Ratings)

A certificate of deposit (CD) is an alternative to a regular savings account. As an investment, CDs offer better interest rates than savings accounts--although you have less access to your money. CDs are insured, just as savings and checking accounts are. This combination of safety and good interest rates is why, as an investment, CDs are so popular. If your investment strategy emphasizes equity protection and income rather than growth, you should learn how to select the best CDs for your needs.

Identification

A CD is a promissory note for money you lend to a bank or credit union that obligates the financial institution to return your money at maturity, along with a guaranteed interest rate. In return, you agree to leave the money with the financial institution until the maturity date. With most CDs, you will be assessed a penalty for cashing in the CD early. For example, on a 5-year CD, the penalty is often 6 months' interest. For a $10,000 CD at 4 percent interest, this is $200.

Features

CDs carry virtually zero risk to equity, because they are insured by the Federal Deposit Insurance Corporation (FDIC). For CDs purchased from credit unions, the insurer is the National Credit Union Authority. As an investment, CDs (particularly long-term CDs) carry only the risk that, should interest rates rise significantly, you are locked into a lower rate until the CD matures.

Choosing CDs

A CD can range in size from a few hundred dollars to "jumbo" CDs with values in excess of $100,000. Larger CDs generally have higher interest rates. Another factor to consider is the maturity. Short-term CDs (those with maturities of less than 1 year) pay lower interest than long-term, 1- to 5-year CDs. The size of the bank or credit union can affect rates. Smaller banks frequently pay higher rates than larger institutions to attract depositors.

Liquid CDs

Sometimes an investor can't be sure she won't have to "break into" a CD before maturity. In recent years, a new type of CD has emerged that is suited to these investors' needs. A liquid CD allows you to make periodic withdrawals from the CD without an interest penalty. Conversely, you can add funds to a liquid CD (there is usually a minimum withdrawal or deposit). Liquid CDs have greater flexibility but do pay slightly lower interest rates.

Considerations

With most CDs, you can choose to have the interest sent to you or have it reinvested to earn compound interest (if you include a CD in an IRA, you must leave interest earnings in the account). When the maturity date arrives, you'll have to decide whether or not to cash in the CD. If you do nothing, in most cases the bank will automatically "roll over" the money into a new CD of equal maturity.