What is CD (Certificate of Deposit)?

A certificate of deposit (CD) is a time deposit that locks in a depositor's funds for a predetermined term (commonly three months to five years) in exchange for a guaranteed fixed interest rate that is typically higher than what a standard savings account offers. The depositor agrees to leave the principal on deposit for the full term. In return, the issuing bank or credit union commits to a set APY that does not change for the duration of the CD.

Under the Truth in Savings Act (Regulation DD), institutions must disclose the CD's maturity date, APY, compounding and crediting frequency, and the specific early withdrawal penalty before the account is opened. Penalties are typically expressed as a number of days' or months' worth of interest, such as 90 days of simple interest on a 12-month CD or 180 days on a 24-month CD. The penalty is deducted from the interest earned (and, if necessary, from principal) when funds are withdrawn before the maturity date. Some institutions offer no-penalty CDs that allow early withdrawal without forfeiture of interest, usually at a modestly lower rate.

CDs are insured by the FDIC up to $250,000 per depositor per institution per ownership category, or by the NCUA Share Insurance Fund for credit union-issued CDs. At maturity, institutions typically provide a grace period (commonly 7 to 10 calendar days) during which the depositor may withdraw funds, add funds, or change the term without penalty. If no action is taken, the CD may automatically renew at the prevailing rate, which may differ from the original.

To balance cash liquidity with yield optimization, investors frequently construct a 'CD ladder.' Instead of committing a large lump sum of capital to a single long-term CD, the investor divides the funds equally among CDs of sequential maturities (such as one-year, two-year, three-year, four-year, and five-year terms). As each CD matures annually, the proceeds are reinvested into a new five-year CD at the prevailing rate. This structure ensures that a portion of the cash becomes liquid every twelve months without early withdrawal penalties, while simultaneously securing the higher yields typically associated with longer maturities. Investors should also note the distinction between standard bank CDs and brokered CDs, which are purchased through investment accounts and can be traded on secondary markets, though they may lack the standard grace periods of direct bank deposits.