What is a Certificate of Deposit?
A certificate of deposit, or a CD, COD, or Time Account, is a savings account that earns interest from the issuing bank over a fixed period. Since the money cannot be withdrawn without a fee or penalty, banks typically offer a predetermined rate of interest, which is generally higher than a typical savings account.
How does a Certificate of Deposit work?
CDs can offer higher interest rates than savings accounts because the money in the account can’t be withdrawn for the entirety of its term. Most CDs will lock you into a fixed rate. The disclosure statement will also include the term, or length of time you agree to leave your rates to avoid a penalty. When the term ends and you redeem your CD, you will receive the principal, or the money you originally paid, plus interest. How interest will be paid out is determined by the bank. Sometimes interest is compounded, meaning it is added to the total amount in the CD account, or the interest may be paid out periodically, such as monthly, quarterly, or annually. Interest may also be paid out at the end of the CD’s term.
CD Account vs. Savings Account or Money Market Account
CDs, Savings Accounts, and Money Market Accounts (MMAs) are all taxable accounts that you can open at a bank or credit union. Both Money Market Accounts and CDs are low-risk investments; however, they differ slightly in their returns and liquidity options. With CDs, you usually set money aside for a fixed period of time and receive a higher rate of interest. MMAs offer higher rates of interest compared to traditional savings accounts and offer more liquidity than a CD. Because MMAs offer more liquidity, the interest rate will likely be lower than it would be in a CD. CD interest rates are fixed from the beginning of the CD account’s term until its maturity date; MMAs have interest rates that fluctuate over time; traditional savings accounts will have the lowest interest rates of the three.
