Certificate of Deposit (CD)

How CDs work

The mechanic is simple. You deposit a sum (typically $500 to $10,000 minimum, varying by bank) for a fixed term — common terms range from 3 months to 5 years. The bank pays a guaranteed interest rate for that term, expressed as APY. At maturity, you receive your principal plus interest. Withdrawing early triggers a penalty, typically equal to several months of interest.

CDs are insured by the FDIC up to $250,000 per depositor, per bank, per ownership category — same coverage as a regular savings account.

Why the rate is higher than savings

A regular savings account lets you withdraw any time. The bank can't fully count on your deposit when planning its lending activity. A CD locks the funds for a known period, letting the bank match the deposit to longer-term loans without the risk of sudden withdrawal. The bank pays a premium for that certainty — typically 0.25 to 1.5 percentage points above its current high-yield savings rate.

The premium widens during periods when the yield curve is steep (long rates much higher than short rates) and narrows when it's flat. During an inverted yield curve, short-term CDs sometimes pay more than long-term ones — the opposite of intuition.

CD ladders

A common strategy: instead of putting $25,000 into a single 5-year CD, split it across five $5,000 CDs maturing 1, 2, 3, 4, and 5 years from now. Each year, one matures and gets reinvested into a new 5-year CD.

The benefits:

• Average rate over time approaches the long-end yield.
• One-fifth of the money becomes available each year if needed (without penalty).
• The portfolio stays diversified across the rate cycle, smoothing rate-timing decisions.

CD ladders work best for cash you don't need imminently but might need eventually — a partial bridge between emergency fund liquidity and longer-duration bond yield.

When CDs make sense

CDs serve a specific niche between regular savings and bond investing:

• Cash you definitely won't need before maturity. A 5-year CD beats a 5-year Treasury bond only when you can wait — early-withdrawal penalties typically wipe out any rate advantage.
• A predictable rate environment. When you expect rates to fall, locking in current rates with a longer CD makes sense. When rates are rising, shorter CDs let you reinvest at higher rates sooner.
• Conservative portfolio component. CDs and high-yield savings together cover most short-term cash needs without requiring a brokerage account.

Brokered CDs

Banks sell CDs directly. Brokerages (Schwab, Fidelity, Vanguard) also distribute CDs from many banks through a single account. Brokered CDs let you compare offers across many banks easily and can be sold on a secondary market before maturity (no penalty, but with potential price discount or premium depending on rates). The rates are usually similar to or slightly better than direct-bank CDs, especially at the higher end.

When they don't make sense

Two cases where CDs are usually the wrong tool:

• Long-horizon retirement money — for funds that won't be touched for decades, the CD's certainty is overkill. Equities have produced multi-percentage-point higher long-run returns.
• Money you might actually need — emergency-fund money should stay in a high-yield savings account where it's accessible. The CD rate premium isn't worth paying a penalty if circumstances change.