What Is a Certificate of Deposit (CD)?
A Certificate of Deposit, commonly known as a CD, is a type of savings account that holds a fixed amount of money for a fixed period of time, such as six months, one year, or five years. In exchange for leaving your money untouched for the agreed-upon term, the financial institution pays you interest at a fixed rate. This rate is typically higher than what you would earn in a standard savings account. CDs are considered one of the safest investment options because they are insured by the FDIC up to $250,000 per depositor. A CD calculator is an excellent tool for comparing different CD offers and visualizing how your savings will grow over the term.
How CD Interest is Calculated: APY and Compounding
CD returns are usually advertised by their Annual Percentage Yield (APY), which is the effective annual rate of return taking into account the effect of compound interest. Unlike the simple interest often found in car loans, the interest earned on a CD is typically added to the principal, and future interest calculations are based on this new, larger amount. The more frequently the interest is compounded, the faster your money grows.
The formula for the future value of a CD is based on the compound interest formula:
Where 'n' is the number of times interest is compounded per year. This is a powerful concept that can significantly boost your long-term savings, a principle you can explore further with our Compound Interest Calculator.Is a CD the Right Investment for You?
Deciding whether to open a CD depends on your financial goals and timeline. They are an excellent choice for goals with a specific time horizon where capital preservation is a top priority.
- Good for Short- to Mid-Term Goals: If you're saving for a down payment on a house, a new car, or a wedding in the next 1-5 years, a CD can offer a better return than a savings account without the risk of the stock market.
- Low Risk: Because they are FDIC-insured, your principal is safe up to the legal limit. This makes them a worry-free way to save.
- Fixed Returns: The interest rate is locked in for the term of the CD, so you know exactly how much you will earn. This predictability is valuable for financial planning.
The main drawback is the lack of liquidity. If you withdraw your money before the term is over, you will typically face an early withdrawal penalty, which could be several months' worth of interest. For more information on how CDs work and how they are insured, the U.S. government's FDIC website is an authoritative resource. If you're considering a loan rather than an investment, our Simple Interest Calculator can help you understand the costs.