Certificate of Deposit (CD): definition, types, uses and risks

Key characteristics

When you buy a CD you make a contract with a financial institution such as a bank or a credit union. The contract specifies the amount deposited, the term (maturity date), the interest calculation method and when interest is paid. Interest may compound at regular intervals or be paid at maturity. CDs are sometimes insured by national deposit insurance programs, so they are treated as a relatively low-risk way to store money compared with many market investments.

Types of certificates

• Traditional CD: locked for a fixed term with a fixed rate.
• Jumbo CD: requires a larger minimum deposit and often offers a higher rate.
• Variable or step-up CD: allows for one or more rate increases during the term.
• Callable CD: can be redeemed early by the issuer under specified conditions.
• No-penalty (liquid) CD: permits withdrawal without the usual early-withdrawal fee.
• Brokered CD: sold through a brokerage rather than directly by a bank.

Risks, insurance and taxes

Certificates of deposit are generally low risk, but they are not risk-free. Interest-rate risk means that if market rates rise after you lock in a rate, your funds remain at the lower rate until maturity. Early withdrawal penalties reduce liquidity. In many countries CDs are covered by government deposit insurance up to specified limits, which protects the principal if the institution fails. Interest earned on CDs is taxable as ordinary income in most jurisdictions, so earnings should be reported for tax purposes.

Uses and strategies

CDs are commonly used for medium-term savings goals, capital preservation and to ladder savings to balance yield and liquidity. A laddering strategy staggers maturity dates across several CDs, so portions of the savings become available periodically while the overall portfolio can still benefit from longer-term rates. Other uses include parking an emergency cushion in a liquid CD or combining CDs with other fixed-income instruments to diversify a conservative portfolio.

History and relation to other deposits

The term certificate of deposit is most familiar in the United States, though the general concept — a time deposit — exists worldwide under different names and legal frameworks. CDs are a type of time deposit, distinct from demand deposits because they require the funds to remain deposited for a specified time. Over decades, institutions have created many CD variations to meet savers’ preferences for yield, flexibility and liquidity.

Before opening a CD, compare rates, terms, early withdrawal penalties and insurance coverage. Shop across institutions to find a product that fits your time horizon and liquidity needs, and consider combining CDs with other savings vehicles such as savings accounts and short-term bonds to build a resilient cash-management plan.