There are several reasons not to invest in a bank certificate of deposit (CD). When you invest in a CD, your money is locked away at an extremely low interest rate, especially compared to the rate of inflation. If you try to get your money released earlier, you will do so at a substantial penalty. At the same time, the bank may reserve the right to call in your CD before the maturation date, although this does not often happen.
Nearly all CDs have a minimum required deposit, usually $1,000. Amounts below the minimum are not eligible for a CD.
The money invested in a CD is always locked away for a fixed term, which may be as little as 30 days or more than five years. In general, the money cannot be accessed before the CD’s maturation date. However, early withdrawal is possible if you pay a penalty. A typical penalty for early withdrawal on a five-year CD is six months interest, but some early withdrawal penalties can cut into the principal. Always read the fine print carefully.
If you think you might need to tap into the money before the CD matures, this is not the investment for you. A high-interest savings account often offers comparable interest with much greater liquidity, although if you are not careful, the fees here can add up as well.
CD interest rates are usually close to the rate of inflation, especially in short-term CDs with lower principals, so it is difficult to do much better than to break even. At the time of writing, most short-term CD rates were just over one percent, while the U.S. rate of inflation is around 1.7 percent.
However, long-term CDs for larger investments generally have higher interest rates than short-term CDs. Some CDs are laddered to give increasing interest rates each year over a five-year period, with the interest rate in the final year roughly triple that of the first year. Under these conditions, CDs can make a stable, safe investment to anchor your portfolio.
CDs are insurable under the Federal Deposit Insurance Corporation (FDIC) rules, to a maximum of $250,000 per owner or co-owner. Thus, very large CDs may not be fully insured under FDIC rules.
A new way around this is the Certificate of Deposit Account Registry Service (CDARS), which spreads out large investments over a large network of banks so that no single CD exceeds the insurable amount, while still dealing with a single bank for statement purposes. This way of dealing with large CD accounts is eligible for “pass-through” FDIC insurance.