CDs are investments that are entered into with a fixed amount of money and for a fixed amount of time.  The amount of money that is placed in the CD is referred to as the principal.  The amount of time is referred to as the term. 

 

Banks may insist that you come into the bank to acquire a CD or they may allow you to get one online.  CDs are FDIC insured up to $100,000, making them a safe and secure investment.

 

The entire amount of the principal will be returned to you when the CD comes to maturity at the end of the term.  Additionally, the guaranteed rate of interest that has accumulated over the term of the CD will also be returned.  The interest accumulates over the entire term of the CD.

 

Terms are offered in a wide range of months or years, but the most popular terms are three months to three years.  Typically, the longer you allow the money to sit or the longer the term you agree to take, the higher the rate of interest is.

 

In general, CDs earn higher interest rates than liquid savings accounts.  CDs lock in the interest rate at the time they are acquired.  Ideally, you want to lock in a good rate while not locking it in for so long that the interest rates on CDs change drastically.

 

When the CD matures, in addition to collecting the principal and the accrued interest, you have the option to allow the CD to roll over and begin again at the same term but with the current interest rate that has been set for that term.  You also have the option to close the CD and transfer the money into a new CD with a different term. 

 

Finally, you have the option to close the CD and take the monetary amount.  Many banks issue the CD balance in the form of a bank check, which you can then cash.  The disadvantage of a CD is the penalty that is imposed should you decide to withdraw your money early or before the term has expired. 

 

The holder of a CD decides at the time he acquires it whether he wants to collect the interest or allow it to accrue.  Depending on the size of the CD, it may be easier or more beneficial to do one over the other.  Larger CDs may provide a nice tidy sum that can be used for personal expenses.

 

Several types of CDs are available and include each of the following varieties.

 

Traditional

 

As explained above, the traditional CD is one that has a specified term and interest.  An early withdrawal penalty is imposed, and the amount must be disclosed with the initial paperwork.  If the investor decides to rollover the CD upon its maturity, the inclusion of

additional funds is usually permissible.

 

Brokerage

 

Brokerage CDs are the same as bank CDs with the exception that they are sold through a brokerage.  Quite often, a brokerage CD offers higher interest rates than a bank CD.  Brokerage CDs are able to offer higher rates simply because they are offered in a national market.  Local banks have a more limited range of clientele and therefore, they cannot afford to offer high interest rates. 

 

Banks looking to expand their sales of CDs will use a broker to market them.  Additionally, such CDs are more liquid.  They can be traded on the market.  The best way to guarantee your rate of return, as with bank CDs, is to hold onto the CD until its maturity.  The FDIC backs brokerage CDs.

 

Bump-up

 

Bump –up CDs allow the holder to request a change in the interest rate applied to the principal.  A consumer would have to initially acquire a bump-up CD in order to have this option.  This type of CD allows the investor to take advantage of a changing market. 

 

Typically, the initial interest rate on the CD may be slightly lower than a traditional CD.  Moreover, most banks that offer the option of a bump-up CD will only allow one bump up per term.  However, once you request the bump up, it will take place for the remainder of the CD term.

 

Liquid

 

A liquid CD allows withdrawals from the CD without incurring a penalty.  The first withdrawal can only be made after a specific amount of time has passed.  Federal law dictates that this is no less than seven days; however, banks may extend that to any number of days.

 

If considering a liquid CD, it is important to discover the number of penalty free withdrawals that can be made during the term in order to determine whether this will meet your needs.  Unfortunately, liquid CDs often offer lower interest rates than traditional CDs.  However, the interest rate should be higher than the money market rate that is offered at that specific bank.

 

Callable

 

A callable CD imposes a regulation that stipulates that the bank may call back the CD after a predetermined amount of time.  The reason for this is to protect the bank’s financial interest while placing the investment risk squarely on your shoulders.  The bank may offer a slightly higher initial interest rate on this type of CD than with a traditional CD.

 

With a callable CD, the bank may take the CD back from the investor before the term has expired and the CD has matured.  The bank will credit the investor with the full amount of the principal and the interest that has been earned up to date.  The CD will then be reissued at a new, lower interest rate for the remainder of the term.

 

Zero-coupon

 

As with zero coupon bonds, the zero coupon CD has no interest component.  Instead, the CD is purchased below the maturity value of the CD.  The investor receives no actual interest payments during the term although they are credited to him.  In fact, the investor must pay taxes on the amount of the earnings each tax year even though he won’t receive the money until the final maturity of the zero coupon CD.

 

High-yield

 

The banks compete for business by offering higher interest rates than the other banks.  In some cases, the difference can be quite large.  Sometimes, the offer for higher interest rates than usual is a limited offer in an effort to drum up traffic quickly.