CD Basics Guide
Investors seeking the best on their low risk savings typically use CDs (certificates of deposit). Depending on the length of the CD, you may achieve interest rates that are superior to savings accounts or checking accounts. The main feature of CDs that attracts investors is the combination of better interest rates with federal deposit insurance (currently $250,000).
Many Different Types of CDs
It is easy for you to invest in a CD. There are a wide variety of CD types that offer many different kinds of certificates of deposit that can suit any specific need that you have. However, given the increasing complexity of CDs, you need to understand all of the terms of the CD in order to avoid an investment decision that is not right for you.
Important CD Terms
There are many terms that are associated with CDs that are important for potential investors to consider.
- CD Yield. When defining certificate of deposit yields, the yield is determined by dividing the interest payments from the CD by the average of the investment on an annual basis.
- Annual Percentage Yield. A CD APY, or annual percentage yield, is the term used for how much a deposit a CD will earn the investor, factoring in the timing of the interest payments.
- CD Return. A CD rate of return is considered to be the gain over a specific period of time that is measured as a percentage increase over the original amount of the investment.
- CD Interest Rates. CD interest rates refer to the amount that the issuer has promised to pay the investor for making the investment in the CD.
- CD Maturity. The maturity of a CD is the length of time that the certificate of deposit will remain outstanding until repaid. This can vary from 3 or 6 months to much longer maturities.
- CD Penalties. An investor may face CD penalties if the cancel the CD prior to its maturity.
- CD Call Features. Some CDs may allow the issuer to call the CD and return the invested money with interest to you before maturity.
Types of CDs
There are several types of certificates of deposit.
- Traditional CD. Traditional CDs remain at a fixed interest rate over their entire duration. In some cases, periodic interest rates may be reinvested into the traditional CD rather than paid out directly to the investor.
- Zero-Coupon CD. This type of certificate of deposit does not make periodic payments of interest. These CDs are issued at a deep discount to par value. Over time, zero-coupon CDs automatically reinvest the interest payments back into the certificate so that at maturity, the investor may redeem the CD at par value.
- Callable CD. A callable certificate of deposit allows the issuer the chance to redeem the CD prior to its maturity date. Should this occur, the CD issuer will return the initial investment to the investor along with any interest that is owed.
- Liquid CD. This type of CD, under certain conditions, allows the investor the ability to withdraw money from the certificate of deposit without a penalty. In most cases, the investor will have to maintain a minimum balance in order to do so.
- Jumbo CD. A jumbo CD is a certificate of deposit that is bought with a large denomination – typically $50,000 – $100,000 or more.
Types of CD Issuers
Traditional banks are the primary issuers of bank CDs. However, CDs may also be issued by other institutions such as credit unions, brokerage firms, and other financial institutions. Some of these issuers may offer advantages over bank issuers.
There are now many online banks and financial companies that can offer certificates of deposit to investors. These online financial institutions may be able to offer slightly higher interest rates due to their lower overhead costs in comparison to traditional banks. A brokerage CD may offer more liquidity and higher interest rates than a CD offered by a bank. Brokerage CDs are sometimes traded in the secondary market.
The other terms from these issuers must be investigated to ensure they still have the insurance benefits of bank CDs.