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Basic Information about Certificates of Deposit

Certificates of deposit (CDs) are timed deposits offered by many financial institutions. Credit union certificates may be called certificate accounts or just certificates. (We will call them CDs for this article). They come with some stringent rules. Because your money is expected to stay on deposit until maturity, you may be assessed a penalty if you withdraw your money from it early. Usually, the penalty is three to six months' interest (for banks) or dividends (for credit unions).

Banks and credit unions sell most CDs. The Federal Deposit Insurance Corporation (FDIC) provides insurance for bank CDs up to $100,000 ($250,000 for retirement plan accounts) per depositor. Credit union CDs are insured for the same amounts by the National Credit Union Administration (NCUA). Brokerage firms also sell CDs. They typically look for those with the highest rates and make them available to their clients. However, investors will pay a fee for this service—usually 1 percent or so of a CD's yield. All expenses should be considered prior to signing up for the CD with the highest stated rate because it might not have the highest return after fees are deducted.

The FDIC and NCUA provide insurance for CDs up to $100,000 ($250,000 for retirement plan accounts) per depositor.

Whereas the issuer sets most CD rates, some rates rise with interest rates. These are called rising-rate CDs.

Generally, the more money deposited into the CD and the longer it stays there, the higher the rate paid. Any interest or dividends earned are taxable.

If you see CD returns quoted for both rate and yield, remember that these are two different things. The rate is stated interest/dividends that the CD pays. The yield is what the investor would receive if left on deposit for 365 days and is the compounded rate of return. Compounding means that earnings are paid on the earnings earned.

For example, if the rate is 5.51 percent, the CD's annual percentage yield may be 5.65 percent instead. Financial institutions may compound earnings daily, monthly, quarterly, semi-annually, or annually. Be sure to compare both the rates and yields when comparing investments.