How Do Certificates of Deposit Work, and What Are the Benefits of Getting One?

There are many ways to put your money to work. You want to find a secure place to save your money that will yield maximum returns. While most depositors use savings accounts to stash their cash, putting your money in a certificate of deposit (CD) gives a higher return in exchange for locking their money away. Savers want a financial strategy that yields maximum return with minimum risk. That’s why more savers are purchasing CDs (also called “share certificates” at credit unions). 

Read on to learn what CDs are and get answers to questions such as how do certificates of deposit work, and what are their advantages?

What are certificates of deposit?

CDs are unique savings tools that yield higher returns in exchange for a commitment to leave your money on deposit for a specified period of time. Where most savings accounts offer an average interest rate of around 0.10%, the interest rates on CDs range from 1.00% up to 2.00% or more. If you are willing to put your money away, you can get 10 to 20 times the interest rate of the average savings account.

How do certificates of deposit work? 

The premise is simple: A bank or credit union offers a higher interest rate when you promise to leave your money on deposit for a specific period. Normally, the longer the terms of the CD, the greater the interest rate. There are also penalties for early withdrawal.

Typically, the interest rate paid for CDs is locked, so the interest rate can’t change, and you have a guaranteed rate of return. The terms for CDs vary from three months up to five years. On the maturity date of the CD, you get your original deposit back, plus the interest accrued.

CDs are a great savings tool if you have the cash to put away. Some financial institutions require a minimum deposit of $500, and others require $10,000. Other institutions like iQ Credit Union don’t have a minimum deposit requirement. And you can get even higher interest rates by depositing $100,000 or more into jumbo CDs.

CDs are the perfect investment tool if you are willing to set your money aside and not touch it until the CD matures. If you worry you may need the cash for an emergency or some other reason, other savings tools such as money market accounts (MMAs) pay interest and give you limited check writing ability. 

If you are less interested in guaranteed returns and willing to take risks, you might consider investing in mutual funds, stocks, or bonds. You may get a higher return, but return rates fluctuate with the market and aren’t guaranteed.

What are some considerations you need to make about CDs?

When considering whether a CD is suitable for your investment strategy, you need to consider the following:

• Will you need to access the money before the CD matures?
• What is your appetite for investment risk?

If you are thinking about long-term financial planning, such as retirement, you can include CDs as part of your strategy but should consider investing. If you can weather the ups and downs of the market and have a good financial advisor, investing can yield higher returns.

CDs are ideal if you are risk-averse and want to put your money where you can’t (or shouldn’t) touch it. If you have plans to buy a home or start a business in a few years, a CD may be an ideal savings tool.

What are the advantages of CDs?

When you talk to your financial advisor about CDs, ask about these advantages:

• CDs have different terms for different savers. Find the CD that is best for your financial plan. You can invest for less than a year, or you can choose a CD with a longer term if you have a planned expense, such as a vacation or home renovation.
• CDs can be a hedge against inflation and fluctuating interest rates. A fixed-interest CD gives you a guaranteed interest rate despite changes in the stock market or the prime interest rate. There are variable-rate CDs that fluctuate with the market, but a fixed-rate CD gives you a guaranteed rate of return. Some CDs also offer a “bump up” where you can get a one-time increase in the annual APY earnings to keep pace with changing market rates.
• CDs are protected by the federal government, unlike stocks, bonds, and mutual funds. The National Credit Union Administration insures share certificates, and the Federal Deposit Insurance Corporation insures bank CDs.
• CDs force you to save. If you have trouble saving money, a CD reduces your temptation to rob the piggy bank. All CDs carry a penalty for early withdrawal, so you will lose money if you liquidate a CD before it matures. Locking money away in a CD may be the best way to ensure you have the funds for a planned expense.

How do you include CDs in your savings plan?

There are different ways to include CDs in your savings strategy. You can put your money away in a lump sum for the future or use a more flexible approach such as CD laddering.  

With CD laddering, you invest in multiple CDs with different maturity dates. For example, you may spread $2,500 across five $500 CDs set to mature in one, two, three, four, and five years. Each CD will have a different interest rate; when each matures, you can reinvest it as part of the ladder or reallocate the funds elsewhere.

Everyone wants to get the most for their money. Including CDs along with savings accounts, MMAs, and even investments will create a diversified savings plan that will pay more significant returns and keep you prepared when you need emergency funds. If you’re interested in learning more about how certificates of deposit work and how they can be part of your savings strategy, view our current CD offers or apply online today!