What is a Certificate of Deposit (CD)?
A Certificate of Deposit (CD) is a savings product offered by banks and credit unions that provides an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period of time. Unlike standard savings accounts, which may have variable rates, CDs typically offer fixed interest rates and fixed terms.
CDs are generally considered to be very safe investments because they are FDIC insured (up to $250,000 per depositor) and offer a guaranteed rate of return. This makes them an excellent choice for conservative investors or those looking to park cash they won't need immediately.
Understanding APY vs. Interest Rate
When looking for a CD, you will often see two numbers: the Interest Rate and the APY (Annual Percentage Yield). While they sound similar, there is a distinct difference.
- Interest Rate: This is the simple rate of interest paid on the CD.
- APY: This takes the interest rate and factors in the frequency of compounding. If a bank compounds interest monthly, the APY will be slightly higher than the stated interest rate. Our calculator uses APY to give you the most accurate estimate of your earnings.
How to Calculate CD Returns
To calculate your CD returns manually, you can use the compound interest formula: A = P(1 + r/n)^(nt).
Where:
P is your Principal Deposit.
r is the annual interest rate (in decimal form).
n is the number of times interest is compounded per year.
t is the number of years.
Frequently Asked Questions
What happens if I withdraw my money early?
CDs are designed to be held until maturity. If you withdraw your funds before the term ends, you will likely face an Early Withdrawal Penalty. This penalty usually amounts to a portion of the interest earned (e.g., 3 months of interest for a 12-month CD), but it can eat into your principal depending on the bank's terms.
Should I build a CD Ladder?
A CD ladder is a strategy where you invest in multiple CDs with different maturity dates (e.g., 1-year, 2-year, 3-year). As each CD matures, you reinvest the funds into a new long-term CD. This strategy provides you with access to some of your money periodically while still taking advantage of the higher interest rates offered by longer-term CDs.