Certificate of Deposit - CD

A certificate of deposit – CD is a type of time deposit offered by financial institutions such as credit unions, banks, and thrifts. CDs are risk-free because they are insured and in that, they are similar to savings accounts. The difference between both financial products it that certificates of deposit typically have a fixed interest rate and fixed term, which can range from 3 and 6 months to 1 and 5 years. Certificates of deposits are to be held until maturity when the depositor can withdraw the money and the accumulated interest.

CDs are promissory notes and funds cannot be withdrawn by holders on demand like those in chequing accounts. Withdrawing money often incurs penalty. Penalties are in place to insure that it is not in the interest of holders to withdraw their money on demand. Typically, funds are withdrawn if the holder is in a serious need of money or intends to make an investment that will bring much higher returns.

Banks send notices to CD holders before their certificates of deposit mature. Holders are offered to withdraw the principal and accrued interest or to deposit the money into new CDs. This is known as rolling over. If the bank doesn’t mail such directions, it may automatically roll over the CDs. However, holders may have the option of specifying that the CDs are not rolled over at the time of opening them. At most banks, the purchaser of CDs can arrange for the interest to be sent periodically. It can be transferred into a savings or checking account or mailed in the form of check. Because there is no compounding, this will decrease the total yield.

In terms of interest, certificates of deposit come with a comparatively higher yield because of the slim risks that banks will go broke. The amount of interest that a holder earns depends on different factors such as term of the deposit, amount of money invested, interest rate offered, and the particular institution of choice. Most banks offer certificates of deposit but interest rates are not likely to be competitive, and it is important to shop around.

When looking at interest rates, it should be remembered that higher interest rates generally come with a larger principal, but this is not always the case. A longer term is typically associated with a higher interest rate, but this is not true if recession is expected. Then, an inverted yield curve is observed. To get a higher interest rate, one may look at a smaller banking institution rather than the larger banks. Apart from that, most of the big banks such as ING Direct, TD Canada Trust, and Royal Bank of Canada offer CDs. Finally, business accounts go with a lower interest rate than personal ones.

A major advantage of certificates of deposit is their comparative safety and the fact that holders know their return in advance. CDs earn more in interest than savings accounts, and one is not left at the mercy of the stock markets.

Other financial instruments are similar to certificates of deposits, such as brokered CDs, callable CDs, liquid CDs, and bump-up CDs. Brokered CDs, for example, are offered by brokerage firms which promise to bring deposits into institutions and thus are able to negotiate higher interest rates. The callable CDs are similar to certificates of deposit, but banks have the right to buy back or call the investment. These CDs pay at a premium interest rate.