HOME

What is a Certificate of Deposit (CD)?

A Certificate of Deposit (CD) is a financial product where you agree to deposit money for a fixed period and earn interest on it. CD terms typically range from three months to five years. Generally, the longer the term, the higher the exposure to interest rate risk. Larger deposits or longer-term investments often result in higher interest rates. CDs are low-risk, low-return investments compared to other options. Although their interest rates are typically higher than savings accounts or money markets, they are much lower than the historical average return of the equity market. While there are several types of CDs, our CD Interest Calculators focus on fixed-rate CDs.

In the U.S., the interest earned on CDs is taxable unless the CD is held in a tax-deferred or tax-free account, such as an IRA or Roth IRA. To learn more about tax-deferred or tax-free accounts, visit our CD Interest Calculator or Roth IRA Calculator.

CDs get their name from the practice of issuing physical certificates to depositors before electronic transfers were introduced. Today, transactions are entirely electronic, and certificates are no longer issued.

How to Use CD Interest Calculator

The CD Interest Calculator is a tool that helps you calculate the total balance and interest earned on a Certificate of Deposit (CD) based on factors like the initial deposit, interest rate (APY), compounding frequency, and time period. Here’s how you use it:

1. Enter the Initial Deposit:
   • This is the amount of money you initially invest in the CD.
   • Enter this value in the “Initial Deposit” input field.
2. Choose the Time Period:
   • Specify the number of years you plan to leave your money in the CD.
   • Enter the time in years in the “Time Period (Years)” input field.
3. Enter the Annual Percentage Yield (APY):
   • The APY represents the interest rate on the CD.
   • This value should be entered in the “APY (%)” input field.
4. Select the Compounding Frequency:
   • The frequency with which interest is compounded affects the total amount of interest earned.
   • Options are typically Monthly, Quarterly, Semi-Annually, or Annually. Select the appropriate frequency.
5. Choose the Currency:
   • The CD calculator allows you to select the currency in which the interest will be calculated (e.g., USD, EUR, INR, etc.).
6. Set the Tax Rate:
   • If applicable, set the tax rate that will be applied to the interest earned. This will help you see how much tax will be deducted from the earned interest.
7. Click Calculate:
   • Once all the inputs are provided, click the “Calculate” button to compute the results.
   • The calculator will show the Total Balance, Total Interest Earned, and a Table displaying the year-end balance and interest earned for each year.
   • A Graph will also be generated showing the growth of your CD balance over time.
8. Reset:
   • If you want to start over with new values, click the “Reset” button to clear all inputs and results.

FDIC-Backed CDs

One key feature of U.S. CDs is that they are FDIC-insured. This means that deposits made in FDIC-insured banks are protected up to $250,000. In the event of a bank failure, the FDIC guarantees the safety of up to $250,000 of each depositor’s funds. If you wish to invest more than this amount, you can spread your deposits across multiple FDIC-insured banks to ensure full coverage. Similarly, credit unions are insured by the National Credit Union Administration (NCUA), offering similar protections.

How to Buy a CD

Many financial institutions, including large banks, offer CDs as fixed-income investments. Interest rates on CDs can vary, so it’s essential to compare options to find the best deal. The interest you earn depends on the Annual Percentage Yield (APY), which is a key factor to consider. To buy a CD, you need to make an initial deposit and select the term length. Minimum deposit requirements and broker fees may apply.

When you buy a CD, you are essentially lending money to the bank. The funds from sold CDs are used by financial institutions to lend to others or to cover operational costs. These factors, along with the federal funds rate, influence the interest rates offered on CDs.

History of Certificates of Deposit

While the term “CD” is modern, a similar concept was first used by European banks in the 1600s. These banks issued receipts for deposits, which were then lent to merchants. Interest was paid to incentivize depositors to leave their funds with the bank for a set period. The Federal Deposit Insurance Corporation (FDIC) was created in the 1930s after the 1929 stock market crash to provide security to depositors and regulate financial institutions.

CD yields have fluctuated over time. In the high-inflation period of the late 1970s and 1980s, CD rates were as high as 20%. By 2021, the average rate had fallen below 1%, but rates began to rise again in 2022, reaching over 5% in 2023 and 2024 due to inflation adjustments by the Federal Reserve.

How to Use CDs

CDs are effective for protecting savings and ensuring predictable, low-risk returns. They can be used in various ways, such as:

• Diversifying portfolios: CDs help reduce risk in an investment portfolio, especially as you approach retirement and need stable returns.
• Short-term savings: CDs can be a good option for saving for a specific goal, like a home or car purchase, with a known future need for the funds.
• Accurate return estimation: Fixed-rate CDs are ideal for individuals seeking predictable, low-risk returns.

When the maturity date of a CD approaches, you typically have the option to either roll over the funds into a new CD or transfer the money into a savings or checking account.

Early Withdrawal from a CD

CDs are designed for long-term savings, and early withdrawals usually incur a penalty. The severity of the penalty varies depending on the CD term and the institution. However, in certain interest rate environments, it may be beneficial to pay the penalty to reinvest in higher-yielding options.

CD Ladder Strategy

A CD ladder strategy can help mitigate the drawback of long-term lock-in periods. Instead of investing all funds in a single CD, you divide the funds into multiple CDs with staggered maturity dates. For example, you could invest in 1-year, 2-year, and 3-year CDs. As one CD matures, you can either reinvest the proceeds into a new CD or withdraw the funds.

APY vs. APR

It’s important to distinguish between the Annual Percentage Yield (APY) and the Annual Percentage Rate (APR). APY accounts for compound interest over the course of a year and is commonly used for interest-accruing accounts like CDs. APR, on the other hand, represents the simple annualized rate, typically used for loans or credit accounts.

Types of CDs

• Traditional CD: Offers fixed interest rates for a specified term. Money can only be withdrawn without penalty at maturity.
• Bump-Up CD: Allows you to increase the interest rate if market rates rise during the term.
• Liquid CD: Offers flexibility with withdrawals, though it may have a lower interest rate compared to traditional CDs.
• Zero-Coupon CD: Does not pay interest during the term but is bought at a discount and matures at face value.
• Callable CD: Can be recalled by the issuer before maturity, with higher interest rates to compensate for this risk.
• Brokered CD: Sold through brokers instead of banks, offering a wider range of options.

Alternatives to CDs

• Paying off high-interest debt: Paying down debt often offers a higher return than a CD, especially with high-interest loans.
• Money Market Accounts: These accounts offer security like CDs but with slightly lower interest rates and more flexibility.
• Bonds: Bonds are another low-risk investment option, issued by governments or corporations.
• Peer-to-Peer Lending: A newer form of lending where investors can earn higher returns, but with increased risk.
• Stocks: Stocks tend to provide higher returns over time, but they come with much greater risk.