Certificate of Deposit
By Graham Billings
on June 3, 2010
A Certificate of Deposit, or CD, is an example of an investment method. They are most similar to savings accounts, in which you deposit money, which accrues interest over a certain period, which you can then collect. They are slightly different from savings accounts in that they are expected to run for their entire duration without withdrawal, and as a result, a bank will give a CD a higher interest rate than a savings account. CDs are notable compared to other investment strategies in that they are risk-free. Government institutions insure them, so there is no way the money could be lost. Unfortunately, lower risk investments lead to lower interest rates, but CDs are one of the most popular investment strategies because of the lack of risk altogether.
There are some rules of thumb for CDs. Usually, the more money you put into the CD initially, the better the interest rate will be. As a result, you will get more interest, which will compound and create a lot more wealth in the future. Similarly, the longer the duration of the CD, the higher the interest rate will be. Again, this will create more interest over a longer period. However, the obvious drawbacks to these are that you will have less liquid cash or you will not be able to collect on your CD for a longer period. Consequently, when getting a CD, you must balance the potential interest rate you could get with how much money you need to keep on hand for the future. Usually, the pre-defined cost for withdrawing a CD early makes it not worthwhile to withdraw it, so you are stuck waiting until it matures unless you really need the money.
There are many types of CDs on top of the basic one, and different types are more suitable to different economies. For instance, some CDs have adjustable rates, which are important when in good economic times, because interest rates for other investment opportunities and inflation will rise. In other words, the CD must have a higher rate in order to keep up with the economy and other investment rates.
Although CDs will not create a lot of value because of their lack of risk, they are a good money-saving strategy. The most important thing when getting a CD is knowing what type you are getting, the interest rate, the length until maturity, and if there are any “tricks” to it. Once you know what you are getting, they can be great, low-risk, interest-generating savings.