“CD” stands for “certificate of deposit.” The idea is that you lend money to a bank for a set amount of time (7 days is the minimum, there is no maximum) while accruing interest at a higher rate than what you would earn while the money is in savings. Once the time you’ve agreed on has passed (this means the CD has “matured”), you get the money that you originally put in plus the interest that you have earned throughout. Banks do this so they can take your money and loan it to someone else at a higher interest rate, therefore making money on the loan. For example, if the interest rate is on your CDis 5% and they loan that money to someone else at 6%, they are earning 1% on the loan issued to the other person.
You cannot take the money out earlier than the agreed upon term without paying a penalty. There are some CDs that offer a CD line of credit, meaning that the depositor can take out a loan on the money with a much lower interest rate than a regular loan. This is because they bank has the money should you default on the loan.
Since many banks and brokerage firms offer CDs, they are competitive with interest rates. Obviously, as the investor, you want the highest interest rate. High interest rates are good for savers, and bad for those needing loans. While interest rates change as the economy changes (you can also get a CD at a fixed rate), you cannot guarantee the interest the CD earns, but you can guarantee that you will earn interest. While it’s likely that you won’t be able to retire on the interest earned, if you can put the money in a CD for 5 years or so, you have locked that money away assuring that it won’t get swallowed up by other investments or lost to whatever black hole you have that sucks away all your money.
Types of CDs
Important Factors to Consider
Look at different banks or brokerage firms to get the highest interest rate possible. While that rate isn’t fixed and is susceptible to economic changes, so get it high while you can.
Will you be able to put this money away without needing it during the term of the CD? While CDs earn more interest than a savings account, if you find that you absolutely need the money, you will lose a lot by pulling it out early.
To learn more, read The Pros and Cons of CDs.
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