Certificate of Deposits
A certificate of deposit (CD) is an unsecured promissory note that offers investors steady interest rates and the benefit of federal protection of your principal. CDs are issued with fixed interest rates and a fixed date of withdrawal, known as the maturity date. They can be bought for as little as $1,000 with a term length of anywhere from 1 month to 20 years. CDs are typically issued by commercial banks and are insured by the FDIC for up to $250,000/per individual.
A CD can be a great investment choice if you don’t plan on needing those funds before its maturity date and desire higher rates of return compared to the ones offered by most savings accounts. However, if you are not able to set aside cash for a fixed amount of time, a high-yield savings account may be the way to go.
Questions and Answers about CDs
What is the difference between a CD and a traditional savings account?
While you are able to freely withdraw and deposit funds into a savings account, a CD requires the holder to leave their money with the bank for a fixed period of time. Unlike most savings accounts, if the holder of a CD chooses to withdraw their investment, the holder could end up receiving less than their original investment. Additionally, the holder will forfeit FDIC insurance for cashing in the CD before its maturity. However, most CDs offer a higher rate of interest than a savings or money market account. While CDs do not provide for a high rate of return as compared to riskier investments, the funds are insured and guaranteed by the bank, making them considered by most to be as safe as a cash or savings account.
How does FDIC insurance work with a CD?
The Federal Deposit Insurance Corporation insures FDIC-bank depositors. A CD is no exception to this protection and insures deposits are insured for up to $250,000 per depositor per insured bank and for each account ownership category. The amount an individual’s deposits are insured works on an aggregated basis so that all ownership in the bank is considered against you on account of the $250,000. In other words, if you own two CDs, the one at Bank A is insured up to $250,000, while the other at Bank B can also be insured up to $250,000, granted you have no other deposits at those banks. However, if you own two CDSs at Bank A and whose totals exceed $250,000, you are only insured for the first $250,000.
Small vs. Large CDs
Small CDs are those issued in denominations of less than $100,000, while large or jumbo CDs are for more than $100,000. However, the term length of either CD will typically range from one month to five years.
What are some of the risks involved?
Two of the main types of risks typically involved with investing in CDs are market risk and call risk. Market risk refers to the risk of losses due to movements in market prices. If you need to sell your CD before it matures, you will need to sell it at current market prices. Even though there are normally no fees charged for early redemption, you can run the risk of receiving less than the original price.
Call risk and its associated reinvestment risk pertain to CDs that have a callable feature attached to them. Unlike traditional CDs, callable CDs allow the issuer to redeem or “call” your CD before it matures for a preset call price. Callable CDs normally run a higher risk of being called when interest rates have declined, which would allow the issuer to refinance its interest-bearing securities. In other words, a bank would add a call feature to a CD so that it does not have to continue to pay high interest rates in an environment of low interest rates. A reinvestment risk kicks in when a CD is called early, forcing an investor to reinvest their earnings in a lower interest paying CD.
How can I purchase a certificate of deposit?
All of our advisors at Florida Financial are knowledgeable on certificate of deposits and can help guide you to make sure purchasing one is the right choice for you. Contact us today for a free consultation.
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