What is a certificate of deposit (CD) and how does it work?

a woman calls her bank about certificate of deposit rates

Everyone likes watching their money grow, especially when they don’t have to lift a finger. Imagine a scenario where your savings work hard for you without monitoring. Enter certificates of deposit (CDs), a financial tool that does just that! Let's delve into the mechanics of CDs and how they can help your money flourish without demanding your constant attention.

What is a CD?

A certificate of deposit, or CD, is a special type of savings account with its own unique set of rules. A CD holds a fixed amount of money for a specific period of time, spanning from a few months to several years. During this period, your interest rate is locked in – it won't change, which is a bit like locking in a good deal!

Now, while your money is in the CD, you can't just take it out whenever you want like you can with a regular savings account. Withdrawals are restricted. In return, when the waiting time is over (when your CD reaches its “maturity date”), you will receive your initial investment plus accumulated interest.

In simpler terms, you're setting aside your money for a while without touching it, and when that time is up, you'll have more money than what you started with.

A certificate of deposit might be a good choice if you want to grow your savings in a safe way. Unlike stocks and other investments, CDs are steady and don’t change with the market. This makes them a dependable option when things are uncertain in the economy. Plus, they are also FDIC-insured up to specific limits, guaranteeing your money is protected in the rare event of a bank failure.

While CDs offer stability and growth, they also come with a commitment. Keeping your funds untouched until maturity ensures you reap the rewards. However, if circumstances change and you need to withdraw before the maturity date, remember that penalties and fees will apply. Therefore, it is essential to assess your future financial requirements carefully when selecting a certificate of deposit.

How do CDs work?

  1. Terms and Rates: When you open a CD, you'll choose a specific term or duration for which you're willing to lock up your money. This term can range from a few months to several years. Generally, the longer the term, the higher the interest rate offered. That’s not true in today’s rate environment because we are seeing an “inverted yield curve,” meaning long-term interest rates are lower than short-term rates. Regardless, the interest rate is fixed for the entire term of the CD.
  2. Investment Amount: You will need to deposit money to open a CD. There is typically a minimum deposit requirement, which can vary depending on the bank and type of CD. (The minimum investment amount for Academy Bank CDs is $500.)
  3. Interest Payments: CDs offer fixed interest rates, and this interest is typically paid out at regular intervals, such as monthly, quarterly, semi-annually, or annually. Some CDs, however, might compound the interest, meaning the interest you earn is added to the original investment amount, and following interest payments are calculated based on this increased balance.
  4. Liquidity: One important aspect of CDs is that they are less liquid compared to other types of savings or investment accounts. As mentioned earlier, when you open a CD, you commit to keeping your money in the CD until the maturity date. Withdrawing your money before the maturity date usually results in a penalty, which could be a percentage of your interest earned or a fixed fee.
  5. Maturity: Once the CD reaches its maturity date, you have several options:
    • Renew: You can choose to renew the CD for another term, which means agreeing to open a new CD with the same financial institution for another term, typically at the prevailing interest rate. This new CD often comes with the prevailing interest rate at the time of renewal. It's like starting fresh with a new CD contract.
    • Withdraw: You can withdraw the principal amount along with the accumulated interest.
    • Roll Over: This involves extending the existing CD for another term, often of the same duration as the initial one. In this case, your money doesn't leave the CD; it simply continues to grow in the same account without any break in the investment. The interest rate may or may not change, depending on the bank's policies.
  6. Yield and Returns: The yield on a CD takes into account the interest rate and how often it's paid. The longer the term and the higher the interest rate, the higher the potential yield. Returns from CDs might be lower compared to riskier investment options like stocks or mutual funds, but they provide a stable and guaranteed return.

Academy Bank Certificates of Deposit

Right now, Academy Bank offers high-yield CDs that can help you grow your funds. With a minimum deposit of only $500, you can take advantage of high-yield 9-month CDs at 5.25% Annual Percentage Yield (APY) or high-yield 13-month CDs at 5.40% APY. Other term options may be available with varying APYs.

Open your Academy Bank CD account today or learn more!

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