How a CD Account Works
Financial experts long have recognized savings accounts and bonds as relatively safe investment options. One alternative, the CD account, or certificate of deposit, is like a combination of these two financial choices. You deposit money into a CD the same way you would a savings account. As with a bond, you have to wait until a specified period has elapsed before the account matures and you can withdraw funds.
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Opening the CD and Deposit
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At most banks, to open a CD, you simply need to tell the bank representative you'd like to open a CD. The representative will explain the CD options the bank offers and give you a form to fill out. Then you give the representative the form and the money you'd like to deposit. You probably will need some form of identification, like a driver's license, to verify your identity and residency, as you typically do for most other bank accounts. The representative also may ask for your tax identification number.
Interest
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As the money you've deposited sits in the CD account, it accrues interest, just like it would in a savings or checking account. Most CDs compound interest, which means that you earn interest on the interest accrued. Banks have different policies regarding how often they calculate interest, but banks usually do so weekly, biweekly or once a month. You can reinvest any interest you make on the CD once the CD matures.
Importantly, interest rates are impacted in part by the length of time it takes for the CD account to mature. Banks tend to reward you for having CDs with a longer period to maturity, because they understand you're tying up your money. They also may give better interest rates to preferred customers, so ask what you would need to do to qualify for those rates.
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Maturity
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When you've had your money in a CD account for the full period specified in the CD terms, the account is said to "mature." When this happens, you can withdraw the money in the account, including any interest you have earned, or you can have the bank automatically reinvest the money in a new CD. If you don't tell the bank not to reinvest, they'll assume that's what you'd like to do. It's best to get the date of maturity in writing from the bank so you aren't surprised about how long you tie up your funds.
Advantages and Disadvantages
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Any money you put into a CD account is not immediately accessible. You can withdraw from the account before it matures, but if you do so, you'll incur a penalty and may not get all your money back. CDs also don't have a return as high as some other forms of investment.
CDs are fairly safe investment options. Banks usually insure their CDs through the Federal Deposit Insurance Corp., while credit unions insure their CDs through the National Credit Union Association. This means that if the bank or credit union runs into financial trouble, you still can get your money up to the value the institution has insured. Institutions often limit how much you can have in a CD account, but you can open different CDs at different institutions to invest larger sums. CDs are good options for people who want to curb spending, because you cannot tap the funds without penalty until the date of maturity.
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