Certificates of deposit (CDs) are fixed-interest rate accounts that enable you to earn interest on your savings, provided you maintain the funds for a set time frame. These set time frames, called term lengths, are typically for a 3-month, 6-month, 1-year, or even a 5-year period.
Although CDs can be viewed as a conservative savings option, they’ve become more popular over the last few years due to historically high interest rates. By learning the benefits of CDs and their terms, as well as the strategies you can use to manage them successfully, you can determine whether opening a CD account is the right decision for your financial goals and needs.
Understanding the benefits of a CD.
You can open a certificate of deposit account in a few simple steps. Once you agree to its terms and conditions, you’ll then be able to contribute the required amount to open the CD and leave it in the account until the term ends. It’s vital to review the terms and conditions, as some CDs will allow you to add funds and increase the interest you’ll earn based on the CD’s locked-in term rate.
Like a savings account, your CD account is unlikely to lose money. Most CDs come with no monthly fees and represent a low-risk, conservative deposit product that can double as a powerful savings tool. Banks and credit unions typically compound interest quarterly or monthly to turn a small deposit into greater savings once the CD term is up. However, the interest you earn on a CD is taxed as personal income in the year you earn it.
When should you open a certificate of deposit?
If you want to start maximizing your savings, it’s a good idea to identify your goals for your CD account so that you can develop an interest-earning strategy from the outset. Consider what you want to accomplish by opening a CD and what other financial goals it might help you achieve.
For example, a CD can help you set aside excess cash now so that you will have an even larger reserve within a few years. If you want to take a more conservative approach, you can open a CD with a lower opening deposit requirement. Either way, a certificate of deposit can also help establish a savings habit and build the discipline necessary to maintain the balance rather than withdraw it and face penalty fines.
Certificate of deposit features.
The contract between you and your bank or credit union regarding a certificate of deposit typically includes the term, required minimum opening balance, corresponding interest rate offered, and any early withdrawal penalties that apply. There may be other terms and conditions that apply, so it is important to review the disclosures before opening a CD account.
Terms
CD terms are often expressed as a set number of months or years. For example, the most common terms are 6 months, 1 year, 2 years, and 5 years. You must maintain the required minimum balance for the term to receive interest payments. Choose terms that align with your savings goals. Balance these goals with how long and how much you can safely set aside funds in your CD account without incurring early withdrawal penalties.
Minimum Opening Balance
Most CDs require a minimum opening balance, which is the amount of money you need to deposit at the time of account opening. You can typically deposit more than the minimum and may want to consider this strategy if a higher balance or longer term unlocks a correspondingly higher interest rate.
Like checking and savings accounts, the money you deposit into a CD is insured by the FDIC or NCUA up to $250,000. Although you can open accounts with a higher minimum balance than $250,000, doing so may put excess funds at risk since they may not be insured. For more information visit FDIC.gov.
CD Rates
A CD’s interest rate and corresponding annual percentage yield (APY) can vary. CD interest rates are typically higher than those of the average savings account, even a high-yield savings account (HYSA). However, interest earned on a CD also depends on the corresponding terms and minimum balance.
A higher APY means higher earnings from the funds you deposit. While a higher minimum opening balance may qualify you for a higher CD rate tier, it’s essential to consider both the CD term and rate to get the most earnings.
Early Withdrawal Penalty
If you encounter an emergency or need to withdraw funds from your CD for any reason, there is generally an early withdrawal penalty (EWP). The CD terms and conditions outline these penalties — from how they’re calculated to when they apply.
Each financial institution determines its own rules regarding EWPs. Some equate the fee to interest payments you would’ve earned over a set number of months. Hence, if you may need to access your funds before your CD term ends, avoid opening CD accounts with stringent penalties.
How certificate of deposit rates are determined.
The Federal Reserve (also known as the Fed) is responsible, among its other duties, for setting and reviewing interest rates. Every six to eight weeks, the Federal Open Market Committee (FOMC) meets to rule on the federal funds rate. Based on these rulings, the rate can increase, decrease, or stay the same, which then impacts the interest rates for CDs.
For example, between 2021 and 2023, average CD interest rates tripled or quadrupled, depending on the selected CD terms. In 2022 alone, the Fed raised interest rates aggressively. This hike came on the heels of historically low interest rates in 2020, matched only by December 2008 levels that were intended to stimulate the economy. Keeping an eye on interest rate fluctuations can help you determine when to open a CD account.
Types of CD.
CD accounts generally fall into two categories: jumbo and standard. A jumbo CD generally caters to institutional investors rather than individuals. While jumbo CDs can offer higher earnings given their higher APY compared to standard CDs, they also require a high minimum opening deposit (often starting at $100,000). On the other hand, standard CDs can also offer competitive rates and are more readily available at financial institutions.
You can also explore other CD options with specific features and benefits to meet your needs, including:
Variable Rate
With a variable-rate CD, the APY changes based on a set index rate outlined in the terms and conditions. By definition, the APY varies with that index rate, fluctuating up and down. Most variable-rate CDs earn less interest in the beginning stages of the term, but by opening a variable-rate CD before rates increase, you can help boost your earnings.
Bump-Up / Step-Up
A bump-up CD may initially earn less interest due to its lower interest rate but offers CD account holders the opportunity to increase their interest rate at least once during the selected terms. This flexibility often does come at the cost of a higher minimum opening balance. Depending on the individual CD terms, interest rate increases can occur at a set interval or at the certificate holder’s request.
Liquid / No-Penalty
As the name suggests, a no-penalty CD remains liquid throughout its term. You can withdraw funds as you please without incurring any early withdrawal penalties. However, the downside to liquid CDs is that many tend to start at lower interest rates.
High-Yield
Like high-yield savings accounts, high-yield CDs offer higher interest rates. While high-yield CD account holders may need to meet stricter requirements regarding initial balances, they can earn more savings based on that commitment. High-yield CDs are also an accessible option at many online banks.
IRA
An Individual Retirement Account (IRA) certificate of deposit is a tax-advantaged CD. With this type of CD, you can save for retirement and earn a fixed interest rate. Although IRA CDs tend to offer lower interest rates than their traditional counterparts, the tax advantages can counteract any modest returns.
Brokered
Brokered CDs are riskier than the average certificate of deposit and tend to have complex terms that require a comprehensive review. You obtain a brokered CD from a third-party broker, which may open the door to potential fraud. With a brokered certificate of deposit, you can lose some of your principal balance as well if you back out early, so carefully consider your needs before pursuing this option.
Add-On
An add-on CD is a special type of CD that may not offer the best interest rates based on its features. Specifically, add-on CDs permit you to contribute more to your opening balance (i.e., “add on” funds during your CD term) to realize greater earnings. However, it may be more challenging to find add-on CDs with competitive rates, as interest rates for this option tend to be lower.
Equity-Linked
The earnings on an equity-linked CD are tied to a stock index, such as the S&P 500. Since these CDs require a longer time horizon, they’re often popular with individuals who can afford to put aside a significant amount of money and wait it out for a longer period. Most equity-linked CDs offer terms of five years, but exact terms may vary.
Pros and cons of certificates of deposit.
CDs offer a mix of advantages and disadvantages. As you consider each, think about how they fit into your savings goals and broader financial plan. A useful exercise may be to create your own list of pros and cons to discover how a CD can help you accomplish your savings.
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How to open and manage a certificate of deposit.
If you want to open a certificate of deposit, reviewing the following steps can help you put your best foot forward:
1. Determine how much money you want to put into a CD.
Review your budget and develop a strategy for managing your new CD.
2. Compare CD terms.
Either online or by visiting a Popular Bank location. Look for the best terms and rates that meet your financial goals.
3. Open an account.
Once you’ve selected your CD, follow the steps to open an account, including depositing the minimum balance. Carefully read through the terms and conditions and ask any necessary questions.
4. Track your progress.
As you earn interest, review your monthly or quarterly statements to track your progress.
5. Consider what you'll do at maturity.
When the CD maturation date approaches, consider what you will do with the funds once they become available again based on your overall savings strategy.
6. Take the next step toward your goals.
Upon receipt of the CD maturation notice, take the next step in your strategy (whether it’s using those funds to open another CD, putting them in a high-yield savings account, or any other action that helps advance your goals).
Many people start with a short-term CD to experience the benefits and then move to a long-term CD account with higher rates. If you take this approach, you’ll have a better idea of what to expect and how you can achieve any goals you set related to CD ownership.
What is CD laddering?
Crafting a CD ladder requires opening multiple CDs at once and evenly dividing the principal amount between them. The key to CD laddering is staggering the maturation dates based on a set interval, such as six months or one year, to maximize liquidity and potential earnings. Once a CD ladder is established, maintaining this strategy simply requires opening another CD in the same way.
How do CDs compare to other deposit products?
Certificates of deposit are often compared to savings accounts, which are also low risk. Although you are limited to a set number of free withdrawals per statement period with many savings accounts, accessing your funds within these limitations doesn’t incur a penalty. However, savings accounts have interest rates that can fluctuate.
CDs, on the other hand, offer a fixed interest rate for the account term. Unlike many stocks and bonds, most CD options are also considered low risk and require less effort to manage.
Get started now: Choose a certificate of deposit.
When you’re ready to take the next step with your savings goals, visit Popular Direct to compare CD rates and terms, and discover which CD options meet your goals and needs. Once you’ve found the terms that work for you, create a strategy to reach your savings goals, repeating and refining the process as you build wealth.
