Similar to opening a savings account, a Certificate of Deposit comes with an additional stipulation. That you won’t withdraw the money from the account until a pre-determined period of time has come to pass. Other than that, it’s done just how you would open up a savings account with your financial institution.
How a Certificate of Deposit Works
Think of this as a loan to the bank that you provide them with for a given time (3 months, 6 months, 1 year, and 5 years are the common terms used). What this does is it provides banks with the funds that they need to provide their customers with loans. In exchange for providing the bank with these funds, they provide you with a set interest rate that is locked in for the length of your CD.
Keep in mind that not only do you need to leave the initial deposit in the account for this length of time that you agreed on, but you will have to leave the interest in there as well. The way that the bank profits from this kind of arrangement are giving you less interest than they were paid by the customer that they loaned the money to.
The Benefits of a CD (Certificate of Deposit)
Here are the many benefits that you can receive when going this route.
· A higher interest is provided than it is with checking and savings accounts.
The other types of investment accounts such as interest-bearing checking accounts, savings accounts, mutual funds, and money market accounts often come with a much lower interest rate than if you were to go with a CD. The reason for this is that at any time you can take the funds out, so the bank is limited when it comes to what they are able to do with it.
· Higher interest rates can be easier to find with smaller banks.
It isn’t uncommon for smaller financial institutions to provide you with more interest than some of the bigger banks. They need the funds a lot more and it could help with their overall growth so they want to encourage people to invest with them.
· You will be at a lower risk than other types of investments.
Since the interest rate is locked in and your funds are guaranteed to be returned, the risk is a lot lower than some of the other investment vehicles such as stocks and other volatile investments, which makes it great for those who can’t put their money all out on the line in hopes of seeing it grow.
Don’t forget to shop around before you sign your name on a Certificate of Deposit. It’s the only way that you’re going to make sure that you’re getting the best return on your investment.