A CD (certificate of deposit) is a guaranteed investment tool. Unlike stocks, the principal of a CD cannot be lost, unless the investor violates the terms of the contract with the financial institution. Most CDs are insured by the FDIC, which means that, even if the bank offering the CD fails, your money is safe as long as the investment and earned interest is under the legal limit. Typical CDs have a fixed rate of interest and a maturity date for when the interest is accrued and transferable.
A good rate for a CD can depend upon the type of CD. In general, CDs of less than $100,000 are called small CDs, and CDs of more than $100,000 are called large or jumbo CDs. Rates may be higher for jumbo CDs, though sometimes it is the term of the CD that can dictate its rate more than the balance in the account. For example, an institution might offer a higher rate for a 5-year CD than a 3-month CD. Some institutions also offer special types of CDs that are risk free, meaning the investor has the option of cashing out early. Some CDs let investors change the rate one time during the term. Some institutions offer add-on CDs, in which investors can add to the principal during the term. All of these variations and options have the potential of giving the investor a slightly lower rate, however. The website Bank Deals (see Resources below) lists news and rates about the best CDs rates on the market.
The benefit of finding a good rate on a CD is that the investor can be sure of her eventual earnings at the outset of the investment, and that the principal and interest are safe investments. The FDIC insures the CD for up to $250,000, and may insure greater amounts for joint accounts or trusts. Check with the financial institution to make sure your full investment is insured. Another benefit of CDs is that most financial institutions make them extremely easy to open. Online banks and credit unions are sources of CDs with competitive rates. In 2008, a competitive annual percentage rate on a CD ranged between 4 and 5 percent.
There are negatives attached to CDs with high rates of return. They often require larger investments or investments for a longer period of time, both of which can be risky in a volatile market. If interest rates increase dramatically during the term of the CD, it is impossible to change the interest you are earning without a penalty. To avoid tying up too many funds or being trapped in a low interest rate, many investors opt for CD laddering--opening up several smaller CDs for a variety of terms and renewing them as they mature.
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Securing a good rate on a CD is vital, because the investor's money is tied up for anywhere from 3 months to more than 5 years. Consumers must do a fair amount of comparison shopping, even though the temptation may be to open a CD within their banks. Instead, check the CD rates at Bankrate (see Resources below), and do not leave out online banks. Legitimate online banks offer high CD rates to attract new customers. However, banks in financial trouble also may offer high rates, so it pays to check a bank's rating, a feature offered in many online CD rate comparison charts.
Consumers might assume that, when the Federal Reserve lowers interest rates, CD rates are in trouble. This is not always the case. In times of financial duress, banks may offer high rates to attract new money to the institution. Both consumers and banks like CDs because they offer secure funds for a definite term. CD rates can be as much as 1 or 2 points higher than the interest rate on a savings account.