Certificate of Deposit (CD Primer)

Written by Richard Barrington

Financial Expert

Edited by Kristin Marino

Managing Editor

With investors in a cautious mood, certificates of deposit (CDs) are a natural savings vehicle to consider. However, whereas once CDs were about as plain vanilla as an investment could get, today there are several varieties. This can mean more shopping around, but the hunt can be worth it if you find the best CD rates.

To find the highest CD rates, you’ll want to start by knowing what factors impact those rates, and what different types of CDs are available.

Factors that affect CD interest rates

These things can all influence the yield you earn on a CD:

1. The interest rate market. Current CD rates are affected by today’s interest rate market and the outlook for rates over the term of the CD.
2. Length and size of your commitment. In general, committing more in terms of time and dollars will help you earn better CD rates.
3. Extent of guarantees. The more you are willing to forgo guarantees like a set interest rate, the more upside you might get — and the more risk you’ll be taking.
4. Aggressiveness of the bank. Some banks are willing to pay higher CD rates to attract depositors.

Types of CDs

The basic proposition of a CD is that you commit to depositing money for a set period of time, and the bank pays you an agreed-upon rate of interest on that money. Over time, though, the marketplace has developed a number of twists on this proposition, leading to the following different types of CDs:

1. Callable. This means the bank can close your CD at a certain point, even before it matures. Callable CDs only make sense if they pay more than regular CDs, and if you expect interest rates to be roughly unchanged over the next few years.
2. Flexible. Some CDs give you the option of withdrawing some of your money before maturity without penalty, but this usually means giving up something in the interest rate.
3. Bump-up. These CDs give you the option of resetting your interest rate once during the term of the CDs. This is a handy option if rates rise, but expect that option to cost you in the form of a lower interest rate starting out.
4. Zero coupon. These CDs pay no interest until the end of the term. If these carry a noticeably higher rate than other CDs, it is a good deal. You’ll have to pay taxes on interest accruing throughout the term, but CDs generally require you to pay taxes on earnings you can’t access until the future anyway.
5. Jumbo. Banks are willing to pay more interest to larger depositors. Just be sure you don’t exceed FDIC insurance limits at a single bank (currently $250,000).
6. Equity-linked. These exchange the guaranteed interest rate for participation in some — but not all — stock market gains.
7. Broker-sold. Independent brokers may buy and sell CDs on the open market. This can be a way of finding the best bank CD rates, though Internet resources may help you accomplish the same thing without paying a broker.

CDs are a great choice for investors who desire excellent security but would like to earn a little more interest than a standard savings account typically provides. So long as you are careful only to include money that you won’t need until the maturity date, CDs can provide a strong combination of competitive yields and very little risk.