How a Money CD Works
A money CD, or certificate of deposit, is a timed agreement between you and a bank in which you agree to deposit a certain amount of money in the bank for a specified period of time and the bank then guarantees a specific amount of interest on your deposit.
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Understanding CD Interest
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There are two types of interest you need to concern yourself with when you decide to purchase a CD.
Annual percentage yield (APY) is the total amount of interest your CD will earn over the course of a year. This number takes into account any compound interest that builds up over time.
Annual percentage rate (APR) is the percentage rate that the bank agrees to pay you on your deposit. This number is dependent on certain factors like the federal interest rate and the length of the deposit.
Advantages of a CD
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A CD is considered a low-risk investment for several reasons. The federal government guarantees your deposit up to $100,000 though the Federal Deposit Insurance Corporation (FDIC). Additionally, the return on your CD is not dependent on market conditions; rather, all rates of return are agreed upon when you purchase the CD.
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Disadvantages of a CD
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As CDs are considered a lower risk investment, they are often subject to lower rates of return than more risky investments like the stock market. Additionally you will be forced to pay a high penalty fee should you cash in your CD before it reaches maturity. So, while a CD carries a higher interest rate than a savings account, they are not interchangeable.
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References
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