What is a Certificate of Deposit?

A certificate of deposit is a term bank deposit with a fixed duration and stated interest rate. A CD is essentially a promissory note issued by a bank. A certificate of deposit normally pays a fixed interest rate upon maturity, though some variable-rate versions are available. A more restrictive CD may require an early-withdrawal penalty.

There is a perception that CDs are more secure than commercial paper, since CDs are issued by banks, which are more closely regulated than companies. There is a capped amount of Federal Deposit Insurance Corporation (FDIC) insurance coverage of this investment.

Advantages of a Certificate of Deposit

There are several advantages associated with an investment in a certificate of deposit, which are as follows:

Safe investment. CDs are considered one of the safest investment options because they are typically insured by government agencies, such as the FDIC (Federal Deposit Insurance Corporation) in the U.S. (up to $250,000 per depositor, per insured bank). This means your principal investment is protected, even if the bank fails.
Predictable returns. CDs offer a fixed interest rate, providing guaranteed returns over the term of the deposit. This predictability helps with financial planning, as you know exactly how much you’ll earn.
Higher interest rates than savings accounts. CDs generally offer higher interest rates compared to traditional savings accounts or money market accounts. The longer the term of the CD, the higher the interest rate tends to be.
Low risk. CDs are a low-risk investment option, making them suitable for conservative investors or those who want to preserve capital while earning some interest.
Flexible term options. Banks offer CDs with a variety of terms, ranging from a few months to several years, allowing you to choose one that aligns with your financial goals.
No market volatility. Unlike stocks or bonds, the value of a CD does not fluctuate with the market. This makes CDs a good choice for those who want to avoid market risks.
Encourages savings discipline. With a CD, your money is locked in for a specific period of time. This discourages impulsive withdrawals and helps maintain a disciplined savings habit.
No fees. Most CDs do not have account maintenance fees, unlike some savings accounts or investment accounts.