A certificate of deposit (CD) essentially is a savings account with strings attached. You promise to keep your money in the bank for a certain length of time, and the bank promises to pay higher interest than for a regular savings account.
CDs are considered to be a safe way to save. They aren't tied to the stock market like a money market fund. The Federal Deposit Insurance Corp. (FDIC) insures bank CDs up to $250,000 through 2013 should your bank fail.
The longer you promise to keep your money in the bank without taking it out, the higher the interest rate the bank will pay you. Common time periods range from three months to 10 years. If you need your money before the time is up, you can withdraw it, but the bank will probably charge you a penalty fee.
Some banks have a minimum deposit required. Generally, the more money saved in a CD, the higher the interest rate promised.
When do you think you'll need the money? Early next year to pay your taxes? Five years from now, when your daughter starts college? Next month, when you total your car? Pull out your crystal ball and consider if you think interest rates are going to rise or fall over the next six months, one year or more. If you think they're going up, you may not want to lock into a long-term CD. If you think they're falling, a longer CD may be the smart thing to do. If you have a large amount of money to set aside, you could break it into more than one CD with different time restraints to have flexibility and avoid withdrawal penalties.
Be sure to read the full contract between you and your bank. It's common for banks to include an automatic renewal clause. Also, you'll probably have to name beneficiaries (who gets the money if you die), so don't forget to change your beneficiary if you get divorced or married, have children or decide you want someone else to inherit the money.