Introduction

A certificate of deposit (CD) is a type of savings account that offers higher interest earnings than a traditional savings account, along with the security of guaranteed returns. However, your money is typically tied up for a set period, such as six months or five years, and you may incur a penalty fee for early withdrawal. In this article, we will explore the advantages and disadvantages of CD accounts and guide you on how to open one.

Advantages of a CD Account

CD accounts offer several key benefits compared to other investment options:

Higher Interest Rates Than a Savings Account

Most CD accounts tend to have annual percentage yields (APYs) that are significantly higher than traditional savings accounts. However, CD interest yields can vary based on the type of CD, where you open your account, and the CD’s terms. It’s essential to shop around to find a CD that aligns with your savings goals and financial situation.

Guaranteed Rate of Return

CD accounts are generally considered low-risk places to grow your money, especially compared to more volatile options like stocks and bonds. If you’re risk-averse, a CD can be a good choice since you’ll know exactly how much interest you’ll earn over the CD’s term, and your money won’t be as vulnerable to market fluctuations.

Funds Likely Federally Insured

The money in CD accounts opened at most banks or credit unions is protected by insurance. With banks, the Federal Deposit Insurance Corp. (FDIC) provides up to $250,000 per depositor, per institution, and account type. Credit unions offer the same amount of coverage but are insured by the National Credit Union Administration (NCUA).

Disadvantages of a CD Account

While CD accounts have their benefits, there are also some downsides to consider:

No Liquidity

CDs require you to deposit your money for a specific period, with the expectation that you won’t withdraw any of it until the maturity date. Unlike a savings account, you may not have access to your funds without paying a fee—often a certain number of months’ worth of interest earnings. If you need quick access to cash for an unplanned expense or a short-term goal, a CD might not be the best choice.

Early Withdrawal Penalty

If you need access to the funds in your CD before the end of the term, you could face an early withdrawal penalty. However, some types of CDs, like no-penalty CDs, may not be subject to this fee. Early withdrawal penalties are often expressed in a number of months’ worth of interest earnings, which can be significant depending on the type of CD, the amount invested, and how quickly you withdraw your money.

Lower Earning Ability

While CD accounts tend to earn more than savings accounts, stocks and bonds are better options if you’re looking to maximize your returns. CDs may not maximize gains like more traditional investment options, but they are much less risky since their return rate is fixed and not dependent on economic conditions.

How to Open a CD Account

A CD account can be opened through a bank, credit union, or brokerage. Here’s a closer look at what you’ll need to do before opening your account:

Choose a Type of CD

There are several types of CD accounts to consider, including traditional CDs, no-penalty CDs, jumbo CDs, brokered CDs, IRA CDs, bump-up CDs, and step-up CDs. The best type for you will depend on how you plan to use it and your financial situation. For example, if you think you’ll want access to your CD funds early, a no-penalty CD may be a good option, though they may come with lower interest rates or other fees.

Compare Interest Rates, Terms, and Fees

You’ll want to find a CD with the highest interest rate to get the most return on your money. CDs with longer terms tend to have higher rates, but not always, so compare different offers closely. It’s also a good idea to look at any fees you may be charged, like withdrawal penalties, as these can vary widely. Keep in mind that CD interest rates fluctuate, and some financial institutions may offer promotional CD rates, so check rates, terms, and fees regularly.

Apply for the CD

To get a CD, you’ll need to submit an application online, in person, or over the phone. Typically, the financial institution will provide a disclosure statement detailing how the CD works, including how often you’ll receive interest payments, how you can expect to receive the payments, and if the CD can be called by the issuer.

Fund Your CD

Once you’ve opened your CD account, you’ll need to deposit money to start earning interest. CDs typically require an opening deposit made online or in person. Depending on the type of CD, you may also need to make a minimum deposit, often between $500 and $2,500 or more.

The Bottom Line

If you can set aside some cash for a set time, a CD can be a solid short-term investment option. Although the potential to earn is often lower than with stocks or bonds, your rate of return is guaranteed, meaning your money won’t be at risk from market losses. The money in your CD is also protected when you open an account through an FDIC-insured bank or NCUA-insured credit union. However, if your budget doesn’t allow you to stash cash for an extended period, a high-yield savings account might be a better option. You’ll have the ability to earn more than a traditional savings account, plus the flexibility to access your cash without paying a penalty.

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