CDs are safe assets that generate interest, although you’ll usually lose access to the capital for the CD’s term duration.
Opening a CD account is usually as easy as opening a bank account, and many online institutions make buying a CD simple.
If you want to take advantage of rising rates, advanced strategies like CD laddering are alternatives to buying a single CD and waiting.
Starting a certificate of deposit (CD) is a reliable method for securing guaranteed returns on your funds while exposing yourself to minimal risk. CDs generally offer the most competitive interest rates among various bank account options and come with the added security of federal insurance, unlike investments held in stocks and bonds. Opening a CD account online is straightforward, with little due diligence and legwork. Here's how in 5 simple steps:
1. Decide on the Type and Term for Your CD
First, you’ll need to assess your unique financial circumstances. Besides how much cash you’re willing to invest in a CD, you’ll need to determine which CD is best for you. The primary trait differentiating CDs is their term.
CD terms describe how long the CD generates interest and how long you can expect your capital to be locked up in the asset. CD terms range across the spectrum to suit your needs, from a few months to 10+ years.
The best term for your situation varies as much as the options available. Short-term CDs are likely best if you use the CD to supplement your primary savings account. On the other hand, if you're using a CD as an alternative to bonds when balancing your portfolio, you might prefer a longer term (assuming you don't anticipate needing the cash quickly).
Sometimes, banks let you cash in your CD early if you need the cash in a pinch. This isn't advisable, though. In addition to losing out on planned interest income, you'll usually have to pay a penalty. Penalty calculations are complex, so if you must cash out early, speak with the bank's representative to understand precisely how much the penalty is and if it's worth the cost.
If you buy your CD through your investment brokerage, you may also be able to trade it on secondary markets – if a buyer is willing to take it off your hands. These are typically called brokered CDs. Although you won't pay a penalty, you could lose some principal if the buyer's purchase limit exceeds your price. Your brokerage may also charge additional fees or commissions on secondary market sales.
Types of CDs
Aside from the term, you'll also want to determine which type of CD is best. Standard CDs are those described above, which:
- Are FDIC-insured up to $250,000 per banking institution.
- Offer a fixed interest rate for a set term.
- It must be held through the term, with a few exceptions.
- Trade in $1,000 increments.
- Available as either:
- A single account held in your name only.
- A joint CD account owned by you and another party. Joint CD accounts enjoy the benefit of $250,000 in FDIC insurance each, so you can deposit up to $500,000 with a single institution.
Other CD types include:
- Fractional CDs, which let you invest in $100 increments.
- High-yield CDs, usually only offered by online banks, with higher interest rates than those at your local community bank. These sometimes have higher principal investment amounts.
- No-penalty CDs that let you withdraw early if needed. In exchange for liquidity, no-penalty CDs usually offer less interest.
- Brokered CDs that are tradable on secondary markets.
CD Related Articles
2. Select a Bank to Open a CD Account
Remember that most offered by traditional banks are FDIC-insured. Validating that the CDs offered by the bank you're researching are FDIC-insured is a critical first step. Other assets may yield more but don't have the insurance advantage, so if you somehow stumble upon uninsured CDs, the risk/reward tradeoff doesn't work out in your favor.
Beyond ensuring FDIC insurance, opening a CD account depends on personal preference and whether the bank offers CDs that meet your needs. Primary considerations when shopping around include:
- Annual percentage yield (APY). APY is the CD’s interest rate that accounts for the power of compounding interest over an entire year.
- CD term, as discussed above.
- Whether you can meet the bank’s minimum CD requirements.
- Whether the CD pays interest monthly or when the CD’s term expires.
- How much, if any, must you pay in early withdrawal penalties.
3. Apply for a CD Account
Once you pick a bank and CD type, you can complete a CD application and open your account. You can usually open your CD account online or through the phone, but you may need to visit a branch in person if it's a smaller, local bank. The process is usually quick and painless, but you'll likely need to disclose or present:
- Your Social Security Number.
- Banking information to fund the CD.
- An identification document like a passport or driver's license.
Different banks have different requirements, so if you must apply for a CD account in person, ensure you know what documents you need so you don't waste time traveling back-and-forth.
4. Indicate How You Want to Receive Your Interest
Depending on the CD type, you may be able to pick between monthly interest distributions or let the cash compound and get the principal plus all accrued interest at the end of the CD's term. Generally, compounding is best: if a 12-month CD offers monthly interest at 5%, picking the monthly option nets about $42 monthly. Assuming you kept the interest as cash at the end of the CD's term, you've hit just under $500 in interest.
If you calculate the compounding factor, though, $10,000 at 5% nets a total of $511.62 in interest. It's not a huge difference, but it adds up over time – especially if you're keeping all your cash in CDs rather than sitting in a savings account.
5. Fund Your CD
Now you’re ready to buy your CD. Your account is open, and you can fund the CD via whatever option the bank allows – wire transfer, digital transaction, cash, or check. Remember that you can (usually) fund the CD only once, so ensure you have sufficient cash available to maximize your investment opportunity.
Additional Tips for Opening a CD
Depending on your situation, there are a handful of additional considerations to ponder before determining whether you should open a CD account:
- If you're younger and don't need cash immediately, you may be better off buying stocks to take advantage of the long-term capital gain opportunity you don't get with CDs. Whereas even high-yield CDs hit 5%+ in interest, the stock market's average annual return is closer to 7% - 10%.
- Your bank may offer CD rolling, which reinvests the principal and interest as soon as the CD’s term expires. If you want to take advantage of this, ask your bank whether it’s an option. If not, make sure you remember when the CD’s term ends so you can withdraw or use the cash elsewhere.
- We hit this point above, but APY is the stat to consider when evaluating CDs – not simply the CD’s interest rate. The best part about fixed-income investing for retail traders is compounding interest, so ensure you’re accounting for that in your calculations through APY.
You may also want to consider laddering your CDs, a slightly advanced but beneficial strategy:
If you want to capture upside from rising rates and distribute your cash flow more evenly, you can explore CD laddering, which works like bond ladders. Laddering describes buying multiple CDs with varied maturities, i.e., a 3-month, 6-month, and 12-month CD. Here’s how a typical CD ladder looks:
- In September 2023, you have $30,000, and commit $10,000 each to:
- A 3-month CD at 5.56%.
- A 6-month CD at 5.48%.
- A 12-month CD at 5.37%.
- Your $10,000 (plus about $140 in interest) matures in three months. Now, you have a two-rung ladder with maturities in three and nine months, so you decide to roll the principal into a new 12-month CD. Rate hikes kept coming in the interim, and the 12-month CD yields 5.5%.
So, instead of locking up all your cash in a 12-month CD at 5.37%, laddering lets you spread the wealth (literally) and maintain flexibility while capturing interest rate upside.
CDs are a great tool to take advantage of today’s interest rates while reducing risk and guaranteeing cash flow. Before buying a CD, research your options and come to the table with as much information as possible. Hundreds of CDs are available from many institutions today, so finding the best CD for you is a matter of basic due diligence – but that process shouldn't be neglected.
Is a CD right for me?
If you can afford to lock away capital for the CD’s term duration and want to capture fixed-income interest upside, then a CD might be right for you.
Do CDs have fees?
Generally, the only fee associated with CDs is the early withdrawal penalty fee. You may pay a commission or other fees if you choose a brokered CD and buy through your investment brokerage.
Which CD term should I choose?
CD term selection depends on your liquidity needs and the CD's purpose. If it's to supplement savings, you likely want better liquidity, so a shorter CD term is best. If you're balancing a stock portfolio with CDs, you might want to jump on elevated interest rates today and pick a 5-year or longer CD term.
What are the requirements for a CD account?
Requirements vary by bank but usually include proof of ID, that you’re 18 years or older, and have enough money to meet the minimum deposit.