Financial Dictionary
Atlantic Financial
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A Certificate of Deposit (CD) is paper issued by banks and insured by FDIC.
Banks agree to pay a stated amount of interest on a Certificate of Deposit and
FDIC guarantees those interest payments and the principal. A Certificate of
Deposit is safe from principal risk, but tends to pay low interest rates.
These rates
have historically not kept pace with the rate of inflation.
A certificate of deposit (CD) is a bank liability that is issued in a designated
amount and specifies a fixed interest rate and maturity date. During the last 20
years, certificates of deposits have become more popular among investors who are
drawn to these FDIC-insured financial instruments that also typically pay higher
interest rates than savings accounts. Banks grant a higher interest rate to
certificate of deposit holders, in exchange for keeping funds on deposit for the
agreed-upon term.
Typically, the minimum requirement for opening a certificate of deposit is $500
to earn the bank's disclosed interest rate and annual effective yield. However,
some savings institutions may require minimum deposit amounts of $10,000 or
more.
When shopping for a certificate of deposit, there are a few important factors to
consider, including the CD’s interest rates, penalty for early withdrawal, its
annual percentage yield, compounding, and maturity terms.
While most certificates of deposits offer fixed rates, some institutions offer
CDs with various forms of variable rates that change bimonthly, monthly, or even
weekly. One has the option to select certificates of deposits that have lengths
of maturities that range from 7 to 31 days or from 3 to 48 months or more.
Typically, banks charge an early withdrawal penalty if deposited funds are
withdrawn before the maturity date. The longer the maturity and the larger the
dollar amount placed in the CD, the higher the yield.
It’s also important to look for the highest annual percentage yield (APY)
possible, when deciding where to invest in a certificate of deposit. The APY is
the rate that reflects the amount of interest you will earn on your deposit.
Annual percentage yields also are linked to how often interest on the CD is
compounded and credited. Compounding, often referred to as “interest on
interest,” refers to the frequency that earned interest is added to the
principal of your deposit, so that you begin to earn interest on that amount as
well as on the principal. Basically, compounding means that interest is being
accrued on earned interest. The more frequently interest is compounded, the
greater the annual percentage yield. At some institutions, interest may be
compounded every day, but often, that interest is not credited until quarterly,
at maturity or when the CD is cashed in.
Another important consideration in choosing a CD is the bank policy regarding
maturity terms. Determine whether your funds roll over automatically into a new
certificate upon maturity, and inquire about the bank’s policies about interest
rates. If interest rates do not change in the event of automatic rollovers, then
you may be at a disadvantage if interest rates have increased.
Certificates of deposit may not be the only appropriate selection for
conservative investors. Treasury bills, municipal bonds and other high rated
fixed income investments also offer a high degree of stability as well as
potentially higher interest rates.
Atlantic Financial professional financial advisors offer a wealth of knowledge
about CDs and other investment options. Since 1994, we’ve remained committed to
helping individual and corporate investors with financial planning, mutual
funds, 401(k) plans, IRAs, rollovers, stocks, bonds, CDs, and portfolios and
more. We offer free advice, quotes and financial research, and we’re happy to
answer questions about any of our programs.
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Certificate of Deposit
