Many people wonder whether Certificates of Deposit (CDs) are really worth looking into, much less investing in. And there’s good reason for this with the high rates one may earn with a money market fund. Whether you’re interested in them or not, it’s nice to understand how they work. You never know when a CD might be just the thing for some situation.

The Low-Down

When one purchases a certificate of deposit, he/she invests a fixed amount of money for a specific amount of time. Typical durations are 6 months, 1 year, 18 months, or 5 years although this could vary. While the money is invested, the issuing institution pays you interest usually at regular intervals. You receive the original amount plus any accrued interest when the CD matures. It sounds simple enough, but there are a few things to look out for before you invest.

Watch Out For…

Most CDs come with an “early withdrawal” penalty. If you may need the money at some point during the term, a CD probably isn’t the right product for you. Any interest earned would probably be negated by the penalty charged. If you’re sure you won’t need the money during the chosen term, you won’t have to worry about this type of penalty.

You’ll also want to look into whether the CD you’re considering has a “call” feature. These are mostly found with longer term CDs. When a certificate of deposit is callable, the bank has the right to terminate the CD and return the principle and any unpaid accrued interest. The investor does not have this right. Banks will use this feature if interest rates fall and they can issue CDs at a lower rate.

You’ll also want to confirm the interest rate and know whether it’s fixed or variable. You should receive a disclosure document that details all of this information. You will also want to know when the interest will be paid, be it semi-annually or monthly. If something isn’t clear to you, make sure you ask all the questions you need in order to be completely comfortable with your decision.

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