Apr 7th, 2008
Working Backwards: What’s a Certificate of Deposit?
A Certificate of Deposit, also known as a CD, is a savings certificate which entitles the bearer to receive interest. A CD is time limited in that it is issued with a specific time frame, typically somewhere between one month and five years. When a CD is issued, the interest rate that is paid is locked in until the CD matures; in return, the bearer agrees not to withdraw the principal without paying a penalty. CDs are typically insured by the Federal Deposit Insurance Corporation (FDIC) for American banks or the National Credit Union Administration for American credit unions (hint: if your bank or credit union is offering uninsured CDs, don’t take them up on it!).
CDs are considered among the safest of deposits and subsequently the interest paid on a CD tends to be relatively low. CDs along with money market accounts, government bonds and notes, and commercial bonds are all considered fixed income securities–they are less volatile than the stock market and typically pay a lower rate of return than you may expect with a stock but with less risk. Unfortunately, as they lack liquidity, CDs are not really appropriate for an entire emergency fund, although they could be part of an emergency fund–keep one month’s savings in a money market account and the rest in a one month CD that renews. This approach is a bit more complicated, but may yield a bit more interest.
CDs have a role in the preservation of capital; if you can afford the lack of liquidity and want to make sure you aren’t going to lose your money, get an insured CD at your local bank or credit union. You may not make a lot in interest, but you won’t lose anything either!
