You have many options when it comes to Certificates of Deposit (CDs). Certificates of Deposit are financial accounts used to deposit money for a specific period to earn a stipulated return. Similar to a savings account, they are a low to no-risk investment option. However, unlike a savings account, you typically cannot withdraw your money before the maturity date without incurring a penalty. While they share these characteristics, not all Certificates of Deposit are the same.
How Does a Certificate of Deposit (CD) Work?
A standard Certificate of Deposit is a type of low-risk investment account offered by a financial institution such as a bank or credit union, where money is deposited for a specific term in exchange for earning interest. Terms can range from one month to 10 years.
When the account reaches its maturity date, it guarantees the account holder the return of the principal amount plus the earnings from a predetermined interest rate. However, if you withdraw your money from a Certificate of Deposit early, you are likely to incur a penalty that can reduce or eliminate your interest earnings.
Banks and credit unions offer Certificates of Deposit as a means to attract more capital for a specified period so they can lend it to others and earn interest.
Types of Certificates of Deposit
While a standard Certificate of Deposit is straightforward, there are many types that have branched off from it. Here’s an overview of other types of Certificates of Deposit you may find, how they work, and the advantages and disadvantages of each type.
High-Yield Certificates of Deposit
High-yield Certificates of Deposit offer very competitive interest rates that exceed the national average. For example, while the national average interest rate for a standard one-year Certificate of Deposit was 0.21% in May 2022, the best rates for high-yield CDs offer over 2%.
You can find high-yield Certificates of Deposit from online banks and credit unions. Why? Because online banks often have lower operating costs, allowing them to offer higher returns, and credit unions are nonprofit organizations that provide high returns instead of retaining profits.
Choosing a high-yield Certificate of Deposit is beneficial because you can earn more money with the same investment. But be sure to read the terms and conditions to understand any restrictions on your earnings, such as the possibility of the certificate being callable (more on that below).
Market-Linked (or Equity-Linked) Certificates of Deposit
A market-linked or equity-linked Certificate of Deposit is a type of account where the return rate is tied to the performance of a certain stock index, such as the S&P 500. These CDs usually have longer terms (about five years), and the return rate is calculated at maturity.
The downside of market-linked Certificates of Deposit is that there is usually no guarantee of a payment over the principal amount. Additionally, the principal may not be guaranteed if not kept in the account until the maturity date. However, on the positive side, you could potentially earn more than you would with other fixed Certificates of Deposit.
Note: Market-linked Certificates of Deposit may set a cap on the amount you can earn in a year, regardless of stock performance.
Jumbo Certificates of Deposit
Jumbo Certificates of Deposit are for those who want to deposit large amounts—think $100,000 or more. By depositing a large amount, you can earn a higher return because interest is calculated as a percentage of your total deposit. However, Jumbo CDs often have lower annual yields than non-jumbo CDs.
Source: https://www.thebalancemoney.com/types-of-cds-5221550
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