Beginner's Guide to Certificates of Deposit

For beginning investors, it can be difficult to understand and choose from the many different options for saving and investing that are available in the market today. One basic option that allows the investor to realize long term profit, but with little risk is a Certificate of Deposit.

What is a Certificate of Deposit?
According to Justin Pritchard, Certificates of Deposit, often referred to as CD's, is a product that is offered to consumers by banks, credit unions, and other financial institutions Usually the CD's are insured by the FDIC or NCUA, removing most all risk from this investment.

A Certificate of Deposit is essentially a time-limited deposit. This means there is a specific period of time that the deposit is unavailable for withdrawal (without penalty). A minimum amount of money is deposited by the consumer for a fixed term, with a fixed interest rate. If the money is left until maturity, it may then be withdrawn with the accrued interest. CD's can mature over a varying range of time, from three months to years from the date of deposit.

This is different from a standard savings plan, because the banks pay a better interest rate in exchange for the consumer's agreement to leave the money in the bank for a fixed period of time. Though fixed rates are generally the standard for a certificate of deposit, there are CD's out there that offer variable rates in different forms. Some CD's are linked to the stock market or bond market, and these rates often vary as well.

Tips for Purchasing a Certificate of Deposit

Longer terms may mean better interest rates for CD's, but it is important for investors to verify this with each CD, as this depends upon the yield curve. Further, smaller banks and credit unions are often more profitable choices, as they often offer higher interest rates than larger banks. Remember also that business CD's often do not enjoy as high a profit margin as personal CD's.

Each financial institution pays differently. Some pay more for a larger deposit, or principle, while others pay less for larger (Jumbo) CD's. Many institutions offer to periodically pay interest accrued on the account during the term of deposit, but choosing this option means losing money in the end, as there is no compounding of the interest.

Make sure that you ask your bank to explain all of the terms of the CD, and also read any paperwork - especially the fine print. Ask about anything that is not absolutely clear. It is also a good idea to ask about other CD options (smaller deposits, larger deposits, shorter terms, longer terms) and the difference in the interest rates or yield at that particular institution. If a CD pays the same interest over a six month period as a twelve month period, it can be better to get your profit sooner, and reinvest. Believe it or not, some banks do not offer higher interest rates for longer terms.

Remember that withdrawing a CD early most often subjects the consumer to a serious financial penalty. It is generally in the depositor's best interest to let the CD mature unless the holder has an opportunity to invest in a higher yield, low risk option, or has personal circumstances that absolutely require it. If you must cash out early, do so in person. In his article CD Penalties - Basics, Tips, and What to Expect, Joshua Kennon asserts that some friendly institutions have waivers of penalties for certain circumstances, but it is imperative that these requests be made in person.

With market "corrections" and fluctuations of up to nearly 800 points recently, many new investors are wary about getting started investing. Financial markets are highly volatile, and vary greatly from institution to institution. Informed investments in CD's may be a good alternative to the stock market for those afraid of high-risk investment.