Banks sell certificates of deposit, also called CDs, which are considered low-risk, but they also have a fairly low-return — this is an investment that is appropriate for cash you will not need for months or years. If you don’t touch the money during the investment period, referred to as the duration or term, the bank will pay an interest rate to you that is somewhat higher than what you would earn unless you have it in a tax-free account.
Here are the most common kinds of certificates of deposit
Bump-up certificate of deposit
This account type lets you swap your CD’s interest rate for a higher one if the rate on new CDs of a similar time period goes up during your investment period. The majority of institutions offer this type of certificate of deposit where they allow you to bump up once during the CD term and keep the interest rate for the remainder of the original certificate’s term.
Traditional certificate of deposit
You earn a fixed interest rate over a specified time period. When that term ends, you will either withdraw your money, or you will roll it into a new certificate of deposit. If you decide to withdraw prior to maturity you could pay a hefty penalty.
Liquid certificate of deposit
This account lets you withdraw part of your deposit without having to pay a penalty. Usually, this CD has a slightly lower interest rate than others, but this rate is still higher than what you would earn in a money market account.
Callable certificate of deposit
A bank issuing this type of certificate of deposit is allowed to recall it after a certain period, returning to you your deposit plus the interest that is owed. Banks will do this if there is a significant decline in interest rates below the rate initially offered. To make this type of CD attractive, a bank will usually pay a higher interest rate. These accounts are usually offered through brokerages.
Zero-coupon certificate of deposit
This certificate of deposit type doesn’t pay annual interest, but rather it re-invests the payments so you will earn interest on the higher total deposit. The interest rate that is provided is somewhat higher than other CDs, but you will owe taxes on the interest that is reinvested.
Brokered certificate of deposit
This term refers to any CD a brokerage offers. Brokerages have access to thousands of banks offering CDs. That includes online banks. Brokered CDs usually carry a higher rate of interest from online banks or smaller banks because they must compete nationally for the investor’s dollar. However, you have to pay a fee to purchase the certificate of deposit account.
CDs are one of the safest investments a person can make. The investments’ interest rate is determined far in advance, and you are always guaranteed to get back the initial investment plus interest at the end of the certificate of deposit term. If the bank should go under, your deposit is insured by the FDIC for a maximum of $250,000.