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If you’ve visited a bank or financial institution lately, they may have offered you the option to open a certificate of deposit or a CD. A certificate of deposit is a unique type of savings account. Basically, the account holds a fixed amount of money for a fixed period. Then, over the course of the agreed upon time, the bank pays interest on the amount in the account. Certificates of deposit are considered low-risk with moderate returns.

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CD vs. Savings Account

The most dramatic difference between a savings account and a certificate of deposit is that a savings account lets you transfer money in and out relatively freely. A certificate of deposit requires that you agree to leave a certain amount of money in it for a certain amount of time. If you need to withdraw your money early, there is usually a fairly hefty penalty. The amount in the account and the issuing institution determine the exact amount of the fine. Typically, early withdrawal penalties are equivalent to a certain amount of interest.

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Benefits of CDs

If you’re absolutely sure you won’t need the money for the period to which you agree, there aren’t many negatives to opening a certificate of deposit. The higher the amount in the account and the longer the agreed-upon term, the higher the rate of interest the institution will pay. The interest rates on CDs are usually significantly higher than the interest rates for a standard savings account. The average annual percentage yield for a standard savings account is around 0.08 percent. For certificates of deposit, it is around 0.76 percent. Each additional year the money remains untouched in the account increases the interest dramatically. The Federal Deposit Insurance Corporation backs many financial institutions, which means any investment is insured for up to $250,000.

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The Risks of Certificates of Deposit

Different financial institutions offer different interest rates and types. When looking into a certificate of deposit, pay special attention to whether the interest rate is fixed or variable. If it’s variable, the interest rate may decrease as time passes. There are also different payment terms. Some banks pay monthly while others pay annually. If the interest rate is too low or the pay rate is too infrequent, there is a good chance that inflation will outpace your investment. Your real returns will be lower because your money will be worth less as time passes.

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Jumbo CDs

This type of certificate of deposit is meant for large investors and businesses. These frequently require a minimum deposit of $100,000. These investments are low-risk, as only the most secure financial institutions usually offer them. Due to the minimum denomination being so high, the interest rates are also significantly increased. Term lengths are flexible and can be as low as a few days, up to several years. The typical length of a term is between three months and five years.

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Bump-Up Certificates of Deposit

The key difference of a bump-up account is that it allows for a one-time option to increase the interest rate. The renegotiation takes place when interest rates on other accounts are increasing, and the investor wants to mirror that with their account. Typically, the financial institution that offers this account will limit the exact amount of the increase. The bump-up certificate of deposit allows investors to increase their returns without worrying about the potential losses of variable interest rate accounts. The starting interest rates on these accounts are usually a bit lower than the standard which means that if interest rates decline, the investor loses out.

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Low/No Early Withdrawal Penalty

Unlike other certificates of deposit, some accounts do not possess an early withdrawal penalty or have dramatically reduced rates. This allows for added flexibility and less risk if the investor needs the money sooner than expected. The institution usually requires a minimum amount stays in the account, and the interest rates are lower than they would be on a standard certificate of deposit.

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IRA CD

Some financial institutions actually offer a certificate of deposit with the tax advantages of an individual retirement account. This offers stability for those who worry about fluctuating investment values and interest rates. These accounts are often more flexible and require a low initial investment. Unfortunately, these accounts have low average return rates.

IRA certificate of deposit

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Deposit Brokers

Usually, investors obtain certificates of deposit through banks or other official financial institutions. However, some brokerage firms or independent salespeople may offer this type of account. By promising to bring a specific number of deposits to the institution, these deposit brokers can argue for higher interest rates. They then offer those accounts to investors. This type of certificate of deposit requires significant research to ensure the issuer is trustworthy and reputable. They aren’t licensed, so they aren’t backed by any federal agency. If you’re curious about a deposit broker, your state securities regulator may have their history and additional information.

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Consistent Returns

Some investors follow an interesting and potentially helpful plan ideal for those who are uncomfortable having their money tied up in a certificate of deposit for years on end. Basically, you put an equal amount of money into one-year, two-year, three-year, four-year, and five-year accounts. Once the shortest term matures, you put the money back into a certificate of deposit with a five-year term length. You continue this each year until eventually, you’re receiving returns from your accounts every year. This allows greater returns and more flexibility.

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Professional Advice

Certificates of deposit aren’t for everyone. They benefit different people in different ways, and there may be better options for you depending on whether you are opening a personal account or a business account, or seeking small or large returns. Speaking with professional advisors and financial planners can ensure you're investing your money well and make your future more financially secure.

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