A Certificate of Depositing: Types, Examples, Definition

Mainly issued by banks, a certificate of depositing, or CD for short is a popular investment instrument. To use it, investors keep their funds locked for a pre-defined period. Banks pay them high returns on a monthly, quarterly, or annual basis depending on specific conditions.

In simpler words, a certificate of depositing definition means one keeps his or her investments aside leaving them for the bank for a fixed time frame.

In this article, we will discuss how CDs work as well as the main pros and cons a certificate of depositing delivers to investors.

Certificate of Depositing Meaning Explained

To make things simpler for beginners, we can describe a certificate of depositing as a premium saving account. It generally offers higher interest rates and bigger returns compared with a traditional savings account.

The main difference is that a traditional savings account lets people use the money whenever they need it. As for the CD, investors must leave their capital untouched until the agreed period is over. In other words, you will not have a chance to withdraw cash or spend money before the end of the tenure. It leads to the lack of liquidity or inability to maintain daily tasks in case of unexpected cash requirements. If one insists on withdrawing funds, it will result in penalties and reduced interest rates being paid off.

When the CD term is over, investors get the original sum plus the earnings generated by the compound interest. Despite the lack of liquidity and certain risks, a certificate of depositing is still one of the most preferable and highly attractive investment methods.

Key Certificate of Depositing Features to Consider

To understand if this particular type of investment suits your needs, we need to highlight some of the main CD features:

1. Fixed Tenure. All funds are locked until the end of the maturity period. The time frame depends on specific conditions. They can vary from several days to weeks, months, or years. The longest period is around 5 years. The most popular tenure is around 6 months.
2. Fixed Sum. One invests a fixed amount. It can vary from one bank to another.
3. Eligibility. A CD usually comes as a financial agreement between a bank and an individual. Additionally, mutual funds, businesses, and trusts may also use this option.
4. Earning. As an investor, you earn an interest rate in exchange for keeping funds locked and untouched. CD can be provided with a fixed or floating rate. As a rule, investors get paid on a monthly or semi-annual basis.
5. Low Risks. CD appears to be one of the lowest-risk investment methods. The main benefit is that they are protected from fluctuation, unlike bonds. What’s more, they are ensured. However, insurance rarely exceeds $250,000. If you invest more, your funds are not safe, if something goes wrong.

The good news is that certificates of depositing are negatable. It means you can sell them in the secondary market.

Certificate of Depositing Types and Classifications

Now that we know all CD features, we can review all available types. They are offering different interest rates and time frame models.

1. Traditional CDs

A conventional type of investment with a fixed interest rate. Its main features include strict penalties for withdrawing cash earlier than agreed. Additionally, funds are protected by federal insurance. In other words, it is a brick-to-mortar type of depositing with higher rates.

2. Bump-Up CDs

This option makes it possible for an investor to raise the interest rate if it increases after the agreement. However, with this CD, investors get lower interest rates compared to the standard one. If the rates do not hike, you will be left with initial earnings.

3. Step-Up CDs

The stand-up certificate of depositing works much in the same way as the bump-up. The only difference here is that the interest rate raises automatically together with the hike. Investors do not have to ask a bank to increase it. The longer the hike, the higher earnings you will get throughout the entire CD tenure.

4. Brokered CDs

To get this type of CD, you need to purchase it via a brokerage account. Banks often team up with brokerage agencies, which makes it simpler for individuals to acquire a certificate of deposit. Another benefit is that brokered CDs are negotiable letting investors sell them in a secondary market.

5. No-Penalty CDs

Also known as liquid CDs, they come with milder conditions. Depositors have the right to use some of the funds, reload the balance or withdraw cash if needed. It makes money management quite flexible, though liquid CDs usually come with a lower interest rate compared with traditional ones.

It is high time we evaluated all CD pros and cons to decide if the tool is worth investing in.

CD Pros:

• Lower risks compared with other popular instruments.
• Better returns compared with traditional savings accounts.
• A chance to find high-yield products provided by banks and financial institutions.
• A chance to reinvest funds in another certificate of deposit.

CD Cons:

• The lack of liquidity. You keep the money untouched under the same interest rate.
• If you use the money before maturity, you will need to pay penalties.
• Lower risks mean lower returns compared with stocks, currencies, etc.
• A fixed interest rate does not take into account inflation. If it grows, it will offset all your earnings.

The Bottom Line

A certificate of depositing is a popular and safe option to get steady earnings. Mainly offered by banks, it offers several models with a fixed or floating interest rate and higher earnings compared with traditional saving accounts. Investors’ funds are protected by federal insurance. The main drawbacks involve lacking liquidity and penalties in case you need to withdraw funds before maturity. For some people, the inability to see their money and keep waiting can be a disaster.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.