What is a CD?


What is a Certificate of Deposit?

If you want to make a little money, lock up your money for a specific amount of time, and have nearly zero risk, a CD is for you.

What's a CD?


This isn't the type of CD that you listened to in your walkman. In this case, CD stands for Certificate of Deposit. Simply put, it's a loan you make to the bank.
  1. Give your money to the bank.
  2. The bank promises to give it back in (3 months, 6 months, 1 year, 3 years, 5 years). During this time you do not have access to it.
  3. The bank gives you interest on it- paying you a percentage for every year they're keeping your money. The more money you lock up, and the longer you can't touch it, the better interest rate you get.


Why does the bank pay to hold your money?


The bank makes money by loaning out money to other people. The more money they're holding, the more money they can loan.

They can loan it out to others at a higher interest rate than the one they are giving to you, meaning they make money on the difference. The use that difference for advertising, paying their employees, building their large buildings, and covering their butts when inevitable a couple of the people they loan it out to decide not to pay them back.

Why don't I just loan my extra money out to my pals then? I know someone who needs a mortgage...


You probably can, but I don't think you should. First of all, the average borrower is far more likely to pay the bank back then they are to pay back their friends.

If you loan it to your friends, and your friends don't pay you back, you are out the money and it's very hard to get it back. The risk is huge. Meanwhile, a bank CD is insured by the FDIC, meaning that if you don't get your money back at the time that was promised, the apocalypse has probably happened and there is no such thing as America anymore.

A CD is a low-paying investment, but one of the safest ones.




So how do I get one?

First, it helps to research CD rates online. Different banks pay different prices. Then, call the bank you thought was best and tell them you are interested in a CD.



What is a CD ladder?

Back when my parents were my age, interest rates were higher and CDs were a lot more popular. One strategy people liked to use for steady income was a CD Ladder.

Remember, when you buy a CD, you make a promise not to touch that money in return for making interest on it. Let's say you need a certain amount of money each year, but you don't need all of it every year.

So you split your money 5 ways and buy a 1 year CD, a 2 year CD, a 3 year CD, and so on.

At the end of year 1, your 1-year matures. You spend the interest and then promptly buy a 5 year CD with the principal (principal is the money you started with.)

At the end of year 2, your 2-year matures, so you spend the interest on that and then buy another 5-year. The 5-year you bought last year now has 4 years left on it, and the 5-year you bought in the beginning now has 3 years left on it.

At the end of year three- you guessed it- your 3-year is ready for harvest. Spend the interest and buy another 5 year. Rinse and repeat.

At the end of 5 years, all your CDs will be 5-year CDs, paying higher interest than shorter ones, but they will be staggered in a way that one is ripe and ready to go every year.

This strategy is really popular with grandmas because it's not risky, but ever since interest rates fell, CDs and CD ladders became less popular. You can do the same thing with bonds, but unfortunately they are not quite as safe an investment as CDs.
 

Disclaimer: This is general education, not specific financial advice.

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