Certificate of Deposit Definition

A certificate of deposit is a short-term savings certificate or debt instrument issued by banks, brokers or credit unions that comes with a fixed interest rate and fixed maturity period. In other words, a certificate of deposit is a low-risk investment option. Many smart investors make use of low-risk investment options like Certificate of Deposit to cushion the effect of high-risk investment options like stock. A certificate of deposit general has a higher interest rate than a savings and a money market account. The principal and interest are available in maturity and there is an option for automatic renewal.

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Types of Certificates of Deposits CDs

  1. Large Certificate of Deposit: A large certificate of deposit has funds of up to $100,000. If you open a certificate of deposit account with over $100,000, such an account will be classified as a large account.
  2. Small Certificate of Deposit: A small certificate of deposit contains less than $100,000
  3. Negotiable Certificate of Deposit: A negotiable certificate of deposit is transferrable and can be sold in the secondary market. The limitation is that you can’t make a withdrawal until maturity.
  4. Non-negotiable Certificate of Deposit: A non-negotiable certificate of deposit can’t be transferred or sold in the secondary market. There is an option to sell before maturity but that comes with attracts a penalty for early withdrawal.

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Advantages of a Certificate of Deposit

Are there reasons why you should go for this type of account instead of a money market account, the traditional savings or checking accounts? The answer is yes, there are some positive reasons or advantages that come with opening a certificate of deposit account. The advantages include

  1. Higher Returns: A certificate of deposit has a higher Return on Investment ROI than a traditional savings account and a money market account. The interest on a savings and money market account can be as high as 1.19% and 2.11% respectively both that of a certificate of deposit is 3% and above.
  2. Low Risk: A Certificate of deposit account is a low-risk investment. The risk of losing your money on this type of investment is very low. Also, Certificates of Deposit accounts enjoy insurance from the FDIC up to $250,000. With this extra layer of protection, you can recover your money even if the bank goes bankrupt.
  3. Cost Free: Unlike a money market fund that comes with a liquidity fee, withdrawal from a certificate of deposit is free.

Disadvantages of a Certificate of Deposit

It is best to mention the disadvantages of this type of account to help you make an informed decision. Despite the advantages that come with this type of account, there are some cons associated with it too.

  1. Not Liquid: Liquidity has to do with the ease of converting an instrument into cash when needed. The certificate of deposit is not liquid. You cannot easily convert it to cash. Withdrawals made before the maturity period attracts some early withdrawal fee depending on the maturity period.

How to Open a Certificate of Deposit Account CD

The process of opening a certificate of deposit is straight forward and similar to the process of opening other type accounts. The steps involved include

Step 1: Decide What You Want from The Investment

Many people skip this process and go straight away to make the wrong choices when opening a CD. The first thing you need to do is to decide what you want out of the investment. Decide amount you wish to invest and also decide how long you want to keep your money. This will help you when making a choice on the type of Certificate of Deposit to pick

Step 2: Make A Choice of Financial Institutions

The financial institutions that offer this type of account are the traditional banks and credit unions. Carry out research on the banks and find out more details on Certificate of deposits for each bank. For instance, the interest rate, maturity period and minimum balance for this type of account vary with most banks. Always ensure that the financial institution you use is fully insured by FDIC.

Step 3: Reach out to The Bank

After you’ve made a choice of financial institution, the next step is to reach out to the bank. You can get the customer service’s number from the bank’s website or you can pay a visit to any of their branch near you. When going to the bank, it is advisable to go with a means of identification and the required minimum balance. Most times, this type of account is created electronically.

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In conclusion, you’ve learned that a Certificate of deposit is a low-risk, low-interest rate investment option. You’ve also learned that this type of investment has a fixed maturity date and fixed interest rate. If you are looking for a low-risk investment to balance out your high-risk portfolio, you can consider setting up a Certificate of Deposit.