Investing Tips: Certificate of Deposit and Savings Account Terms
If you are looking to gain interest on your money in the short term, or if you need a stable investment option while the stock market is unpredictable, opening a certificate of deposit (CD) is a viable option. Regardless of your individual financial goals or the depth of your current investment portfolio, it’s helpful to understand relevant terms related to various investment options, like a bank certificate of deposit.
Annual Percentage Yield (APY): The actual amount of interest paid to you each year from a long-term investment, taking into account compounding interest.For example: investing $10 at 10%, compounded each month,you will earn roughly $1.05.
Annual Percentage Rate (APR): The rate of interest earned in one year. For deposit accounts the term "interest rate" is more appropriate. This number does not reflect the effect of compounding interest.
Automated Clearing House (ACH): An electronic network for financial transactions. It is a secure system developed to handle the clearing of electronic transactions between all US financial institutions. Online banks often allow customers to initiate ACH transfers to make deposits or withdrawals.
Automatic Renewal: An option that will automatically re-invest the money in a certificate of deposit if no withdrawal is made during the grace period following maturation of the CD.
Bank CD Rate: Depending on the financial company or bank backing the CD, a range of CD interest rates can be offered. Bank CD rates depend on two factors – length of time before the maturation of the CD and the current interest rate environment.
Callable CD: The bank has the ability to "call" or terminate the CD after the call-protection period has expired but before the maturation date. This allows banks the opportunity to end a high-yield CD in the event that interest rates fall. More risk is assumed by the depositor with a callable CD than with a normal CD.
Certificate of Deposit (CD): A financial product that pledges to return your original investment plus interest on a specific date. CDs offer higher interest rates than standard savings accounts and typically involve little risk when FDIC insured because your investment is guaranteed.
CDs differ from savings accounts in the fact that they have a specific length of investment time – anywhere from one month to five years – and usually have a fixed interest rate. Typically held until maturity, CDs can be withdrawn along with gained interest, but hold penalties (such as less interest) for early withdrawals.
CD Ladder: An investment strategy where the depositor "ladders" or spreads money out among short-term and longer-term CDs while not necessarily tying up all of the funds over a long period of time. For example: suppose an investor has $100 to invest in a CD. Using a ladder strategy the depositor would invest $20 in a one year CD, $20 in a two year CD, $20 in a three year CD and so-on until the entire initial $100 is deposited. Once the first CD matures the investor can roll the money into another five year CD.
Early Withdrawal Penalty: A fee charged to a depositor who withdraws funds from a CD before the date of maturity. The penalty is generally a substantial portion of the earnings and is used to limit the amount funds removed before maturation.
FDIC Insured (Federal Deposit Insurance Corporation): A government institution that guarantees the safety of checking and savings deposits held by commercial banks. For each bank that is a member, each depositor is guaranteed up to $250,000 with the basic coverage. Additionally, the FDIC may insure more than $250,000 for an individual at one insured bank if you own deposit accounts in different categories of ownership. Note, the basic $250,000 guaranty is scheduled to return to $100,000 on 12/31/2009.
Grace Period: The period of time - generally between one to two weeks around the time of maturation - where the depositor can make changes to the CD without incurring any financial penalty. Common changes during the grace period include – adding additional money to the CD, decreasing the amount of the deposit or cashing in the CD. If no action is taken during the grace period the deposit is usually rolled into a new CD with the same terms as the previous CD.
Individual Retirement Account (IRA): A personal retirement fund that provides tax benefits for the depositor. There are many different types of IRA accounts available. Most IRA accounts charge a penalty for removing funds before maturity.
Jumbo CDs: CDs with an initial investment greater than $100,000 that are typically negotiable. Also referred to as a large CD.
Maturity: Final payment date of financial product or investment where all interest must be paid to you in full.
Money Market Account: A deposit account similar to a savings account. It is not considered a 'transaction account' so there are limits placed on the number of transactions and allow for limited check writing (usually three) each month. They typically require a higher minimum balance than traditional savings accounts. Unlike money market funds, money market accounts from U.S. banks are FDIC insured.
Money Market Fund: A type of mutual fund that is generally a low risk investment. They are required by law to invest in short-term, low-risk debt securities of the U.S. Government, Treasury Bills, corporations and banks. There is no penalty for removing money on short notice and provide the ability to write a limited number checks from your fund each month. Unlike bank money market accounts, money market funds are not FDIC insured.
National Credit Union Administration (NCUA): The federal agency that insures deposits in most state-chartered credit unions and all federal credit unions. Coverage limits are very similar to the coverage limits that the FDIC provides to banks.
Payable on Death (POD): The transfer of one’s assets (including CDs, stocks, etc) to a beneficiary upon death. You can set up a POD account at your bank free of charge and doing so will allow for the quick dispersement of assets to beneficiaries without having to use a probate court.
Payment of Interest: Interest is typically payable in different forms - either as it accumulates or added to the original investment and paid at maturity.
Savings Account: A deposit account maintained by a bank that earns interest. Savings accounts are subject to the governance of Regulation D, which places limits on withdrawals, transfers and payments from the account. Traditional savings accounts typically do not allow check writing and withdrawals can sometimes be costly.
Small CDs: CDs where the initial investment is less than $100,000.
Term Lengths: CDs carry fixed terms for the investment, typically short or medium term – generally ranging from one month to five years. The investor agrees to keep money in the account for a specified amount of time upon the initial investment. Banks can offer higher interest rates with a longer fixed term and can impose penalties if you withdraw the investment before the term expires.
Time Deposit: A CD held for a fixed-term or agreed amount of time where the investor can only withdraw funds by giving written notice.
Wire Transfer: The process of transferring money from an individual's or company’s bank account to another. CD deposits can often times be made through a wire transfer, eliminating the necessity to make the deposit in-person with cash. Note, this is different than transfers done by ACH.
If you are looking to invest some money and earn a little interest in the meantime, now is the time to consider a fixed-term investment like a CD. Given the current state of the economy, many banks are offering incredibly high yielding certificates of deposit to spur additional investing. Learn more about investing in CDs and utilize the helpful resources at Citizens Bank to find investment opportunities that fit your life.
Edit 10/20/08: Updated APR definition