By Chelsea Jamison - Seattle Pacific University

You’re all probably aware of savings accounts, the stock market and bonds as common ways to invest and receive a positive (hopefully!) return on your money.

But what about certificates of deposits (CDs)? Why would you invest in one?

Wait… a CD?

Yes… a CD (no, not a Rick Astley CD… a certificate of deposit). It’s basically a savings account set aside for a specified amount of time and accumulates interest. You can’t just throw $10 in there either. You have to start with at least (usually) $500 bucks plus.

The difference between a savings account and a certificate of deposit is that you are entering into an agreement with the bank that you will not cash in on your money until it reaches the maturity date. The interest rate of a CD is usually higher what you would earn in a savings account, because by investing in a CD, you enter into an agreement with the bank that you won’t touch your money until the term is complete. If you do, you usually get slapped with a fee that will eat up the majority of the money you earned from interest. Typically, some online banking services match or exceed your local CD offers, with no minimum deposit requirement.

How does a CD work?

Well you don’t put it in a cd player, that’s for certain. When the agreed upon time period is over, the CD has reached maturity (cash in!). It is at this time when you can cash it and be “compensated” with the accrued interest you’ve earned for lending your money to the bank for this set period of time, including the original amount of money you put in.

What is a typical return on a CD?

CDs are paid in terms of APY (annual percentage yield), so regardless of your length to maturity, you are paid on an annual basis. This means that if you are investing in a 12-month CD at 4.75% APY, you will earn 4.75% interest on your principal. If you are investing in a 6-month CD at the same rate, you will have to divide the rate in half to calculate the true rate of return you will receive for your term.

An APY for a 3-month CD can average around 1-3.5%, depending on your minimum deposit and bank you choose to invest in. For a 12-month CD, the APY average from 1.7-%-3.3% with minimum deposit of $500 or $1,000. Notice the jump in interest rates? The longer you do not have access to your money, the more the bank is willing to pay you. Only fair, right?

For a 2-year CD, you can earn interest as high as 4.25%!

Disclaimer: Some banks may require a higher deposit than $1,000 for a rate as high as 4% and up. These figure are estimates, and are stated to give you an idea of how interest is earned with CDs. Rates vary depending on several factors, including but not limited to your minimum deposit amount, term invested, and most importantly bank you choose to invest with.

Check out our Banking section for more info on the banking industry.

View Chelsea's Profile      Subscribe via RSS