Understanding Certificates of Deposit

Learn more about what a CD is and when you should open one.

Tiles spell out CDS over a background of dollar bills and coins.
(Image credit: Getty)

Certificates of deposit, or CDs, can range from so-called time-deposit savings certificates — available in modest denominations at banks, savings and loan associations, and credit unions — to negotiable certificates requiring minimum deposits of $100,000 or more. 

With a certificate of deposit (CD), you’ll earn a guaranteed rate of return on your hard-earned cash, helping you grow your savings with little effort, risk-free. These risk-free investment options can be beneficial for those who want to earn a fixed, predictable rate of return on their savings. However, before opening a CD account, there's a few things you should know. 

Keep reading to learn more about what CDs are and when you should open one.  

What is a CD? 

A certificate of deposit, or CD, is a type of savings account that holds a fixed amount of money for a fixed period of time, which can be anywhere from three months to five years. In many cases, CD accounts offer higher savings rates than standard savings accounts, but there is a caveat. If you withdraw your money before the CD’s maturity date, you’ll incur a fee, offsetting any interest you may have earned (unless you have a no-penalty CD account). 

Typically, the longer the CD term, the higher the annual percentage yield (APY). However, the market is currently experiencing what is known as an “inverted yield curve,” meaning you’ll earn more from a 1-year CD compared to a 5-year CD. In fact, some of the top yielding 1-year CD rates are over 5% — with several CDs offering rates of over 5.6%. Unlike high-yield savings accounts, you’ll lock-in rates when opening a CD account. This means that if rates go up or down, the APY on your account will remain the same.  

Use the below tool — powered by Bankrate — to compare CD rates today, and try our savings calculator to see just how much you’ll earn from compound interest once your CD matures.  

Before opening a CD, make sure to compare interest rates, early withdrawal penalties and if there’s any other fees associated with the account. Some accounts have minimum deposit and balance requirements that if not met, could result in a charge. 

Also watch for the rollover provision. In some cases, the certificate will automatically be rolled over (that is, another certificate purchased for you) if you don't notify the institution within a specified number of days before the certificate's maturity. 

Why open a CD? 

Because your cash is locked away for a fixed period of time, avoid putting your emergency fund, or any other savings you may need to access, into a CD account. Instead, CDs are good options for particular savings goals, like future purchases or events. 

For example, if you’re planning on buying a car in three years, then keeping your cash in a three-year CD makes sense, as it will help you maximize your savings until that time comes. You’ll have less of a temptation to spend this cash, as you'll have to wait until the account's maturity to withdraw funds or incur a fee. 

If you don’t have a particular savings goal in mind, you’ll need to consider when you’ll need access to your cash and plan accordingly. Or, you can opt for a no-penalty CD account, letting you avoid early withdrawal fees altogether, but usually at the cost of a lower APY.

"The first question to ask is the expected time horizon. If you’ll likely need the cash in 2 years, a 5-year CD is not the best option if there is a penalty for early withdrawal. If you have a 5-year time horizon and think interest rates are going to decrease in the next 12 months, a 5-year CD may be best so that you're locked in at the (hopefully) higher rate," Michael Powers, financial planner at Manuka Financial, told Kiplinger. 

"If you have a 5-year time horizon and expect interest rates to increase," he continued, "you may want to stick with a shorter-term CD (or even better, a no-penalty CD) and then if rates do increase, you will (hopefully) be able to reinvest in a new CD that pays a higher rate."

If you’re looking for a risk-free investment option and want to earn a fixed, predictable rate of return on your savings, saving your cash in a CD account is one way to do so. CDs are one of the safest ways to save your cash, as most are FDIC or NCUA insured. This means that your deposits will be protected (up to $250,000 per account) even if your bank is faced with financial trouble or closes. 

CD ladders

You can reduce the risks of a long-term commitment — and take advantage of long-term rates — by building a CD ladder. This is where you stagger, or ladder, maturities so that some are always coming due in the near future. When your first CD matures, you can either cash out or reinvest this cash into a new CD account to continue building your ladder.

For example, if you have $2,000 to put in CDs, consider putting $500 each in a three-month, six-month, one-year, and two-year certificate. When the three-month CD matures, roll it over into a six-month certificate. Do the same when the first six-month CD matures, and continue rolling over so that you'll always have a certificate within three months of maturity.

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Erin Bendig
Personal Finance Writer

Erin pairs personal experience with research and is passionate about sharing personal finance advice with others. Previously, she was a freelancer focusing on the credit card side of finance, but has branched out since then to cover other aspects of personal finance. Erin is well-versed in traditional media with reporting, interviewing and research, as well as using graphic design and video and audio storytelling to share with her readers.