Certificates of deposit, also called CDs, are savings vehicles that have a fixed maturity date and a fixed interest rate
Why It's Important
CDs generally have higher interest rates than a regular savings account or money market at the bank. But, there is a catch! Remember, in the definition, CDs have a fixed maturity date so your money is tied up until that date. If you want to access your funds early, they will penalize you by charging an early withdrawal penalty. Typically, the farther the CD maturity date is away, the more interest they are willing to pay you. For instance, currently, these are the CD rates at Ally Bank:
So, as you can see, you get rewarded for having your money tied up for longer periods of time.
Use caution: The interest rate on Ally's regular savings account is 2.10%, so would it really make sense to get a 3 month or 9 month CD? Probably not. You are getting more yield having the money in a regular savings account that does not penalize you for taking it out.
When investing, some people will use CDs when they think interest rates will go down. You have the ability to lock in a certain interest rate. This strategy can also hurt you if interest rates increase. Why? Because you are now locked in to a lower interest rate until the maturity date.
Remember when we talked about the FDIC insurance? CDs are covered too up to $250,000 per account per bank!