How Does a Bank CD Work?


Quick Answer

Bank certificates of deposit have specific maturity dates and interest rates, according to Investopedia. They are time deposits, meaning that funds cannot be withdrawn on demand without significant penalties.

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Full Answer

The interest rate is slightly higher on a CD than a treasury bill, reflecting the slightly greater financial risk, warns Investopedia. However, they remain a low-risk investment, especially when purchased from a large bank. The rates that banks offer vary greatly, so when considering the purchase of a CD, consumers benefit by taking the time to shop for the best interest rate.

When investing in a CD, consumers should consider the annual percentage yield as well as the annual percentage rate, advises Investopedia. The APR represents the stated interest rate earned each year, without taking into consideration the effects of compounding interest. The APY represents the actual earnings of the instrument. Each payment increases the principal of the investment for the next payment, so with more frequent payouts, the investor earns more money each year.

The Federal Deposit Insurance Corporation guarantees CDs up to $100,000, making the CD a safe investment, according to Investopedia. With the set interest rate, investors know the return on a CD from the beginning of the term; however, it is much smaller than other investments.

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